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PRINCIPLES   OF   INSURANCE 
VOLUME   II:    FIRE 


THE  MACMILLAN  COMPANY 

NEW  YORK  •    BOSTON  •    CHICAGO  •   DALLAS 
ATLANTA  -   SAN   FRANCISCO 

MACMILLAN  &  CO.,  LIMITED 

LONDON  •    BOMBAY  •    CALCUTTA 
MELBOURNE 

THE  MACMILLAN  CO.  OF  CANADA,  LTD. 

TORONTO 


PRINCIPLES  OF  INSURANCE 


VOLUME  II:    FIRE 


BY 

W.   F.   GEPHART 

PROFESSOR  OF  ECONOMICS  IN  WASHINGTON 
UNIVERSITY 


Nefo  fforfe 

THE  MACMILLAN  COMPANY 
1920 

AH  rights  reservtd 


COPYRIGHT,  1917, 
BY  THE  MACMILLAN  COMPANY. 

Set  up  and  electrotyped.    Published  January,  1917. 


NorfaooD 

J.  8.  Gushing  Co.  —  Berwick  <fe  Smith  Co. 
Norwood,  Mass.,  U.S.A. 


JDUS.  Admin,. 
Library 

H6 
8051 

629 
.2 


PREFACE  V 


THE  literature  on  insurance  is  considerable  in  amount, 
but  that  which  is  accessible  for  use  in  schools  and  col- 
leges is  meager.  Government  documents,  official  reports 
of  insurance  companies  and  of  organizations  of  insur- 
ance officials  and  employees,  pamphlets  and  published 
addresses  on  the  subject  are  the  chief  sources  of  the 
best  information  on  insurance. 

It  is  therefore  because  of  the  conviction  of  the  im- 
portance of  insurance,  the  character  of  the  literature, 
and  the  increasing  importance  of  the  subject  in  the 
curriculum  of  educational  institutions  that  this  discus- 
sion is  offered. 

The  two  volumes  on  life  and  fire  insurance  are  offered, 
not  as  a  complete  discussion  of  these  two  important 
forms  of  insurance,  but  rather  as  a  statement  of  what  is 
conceived  to  be  the  more  important  considerations  which 
should  receive  study  in  a  general  course  in  life  and  fire 
insurance.  The  material  has  been  selected  on  the  basis 
of  the  author's  experience  in  teaching  the  subject,  his 
experience  in  the  business,  and  his  association  with 
insurance  organizations.  As  textbooks,  they  will  need 
to  be  supplemented  by  the  instructor,  by  reference  read- 
ing as  well  as  by  the  use  of  policy  forms,  company 
reports,  government  reports,  and  other  available  material. 

The  author  is  aware  that  his  discussion  of  certain 
questions  relating  to  the  regulation  of  insurance  is 


vi  PREFACE 

opposed  in  some  cases  to  the  prevailing  public  senti> 
ment  and  practice.  But  it  has  been  the  purpose,  not 
only  to  state  as  briefly  as  possible  the  important  facts 
and  principles  of  life  and  fire  insurance,  but  also  to  pro- 
voke thought  and  discussion  on  certain  mooted  questions 
in  insurance. 

An  effort  has  been  made  to  select  such  readings  on 
each  topic  as  would  be  most  helpful.  Much  of  the  best 
literature  is  either  in  pamphlet  form  or  in  the  insurance 
journals.  An  exception  is  made  in  the  case  of  insur- 
ance statistics.  Such  annuals  as  the  Insurance  Year 
Book  of  the  Spectator  Company  leave  little  to  be  de- 
sired in  the  way  of  statistical  literature.  An  exception 
is  also  to  be  made  in  the  case  of  the  German  and  French 
literature,  much  of  which  is  of  a  very  high  character  and 
in  general  much  more  extensive  than  the  literature  in 
English.  Few  references  to  this  literature  have  been 
made ;  first,  because  most  of  it  is  not  accessible  to  the 
reader  of  this  book,  and  second,  because  this  is  an  ele- 
mentary discussion  of  the  principles  and  practices  of 

insurance. 

W.   F.   GEPHART. 

WASHINGTON  UNIVERSITY. 


CONTENTS 

CHAPTER  I 

PACK 

THE  HISTORICAL  DEVELOPMENT  OF  FIRE  INSURANCE       .        .        1 

Periods  in  the  development  of  fire  insurance.  Informal 
organizations.  Lack  of  data  for  scientifically  conducting  fire 
insurance.  Absence  of  wide  diffusion  of  individually  owned 
property.  Character  of  the  industrial  life.  Guilds  in  their 
fire  insurance  activity.  Early  fire  insurance  plans  in  England. 
The  effect  on  fire  insurance  of  the  London  fire  of  1666.  The 
organization  of  Friendly  Societies,  Mutual,  and  Stock  Com- 
panies. Early  English  Companies,  their  plans  of  insurance 
and  field  of  operation.  The  Bubble  Period  and  its  effect  on 
fire  insurance.  Early  American  fire  insurance  organizations. 
Importance  of  Marine  Insurance.  The  effects  of  the  New 
York  fire  of  1835  on  fire  insurance  in  the  United  States.  The 
early  forms  of  regulation.  Development  of  Mutual  Compa- 
nies. The  work  of  the  National  Board  of  Fire  Underwriters. 
Development  of  the  Standard  Fire  Policy. 

CHAPTER   II 

THE  ECONOMICS  OF  FIRE  INSURANCE 27 

The  theory  of  the  group  risk.  The  function  of  the  com- 
pany. Essential  mutuality  of  all  insurance  organizations. 
Comparison  of  the  stock  and  mutual  principle.  Impossibility 
of  self-insurance.  Comparison  of  the  risk  in  fire  and  life  in- 
surance. The  economic  character  of  the  payment  to  the 
insurer.  Relation  of  fire  insurance  to  production.  How 
capital  insures  capital.  Relation  of  insurance  to  credit  and 
distribution.  How  the  economic  costs  of  fire  insurance  may 
be  reduced.  Causes  of  the  large  losses  by  fire  in  the  United 
States.  Insurance  as  a  competitive  and  monopolistic  busi- 
ness. To  what  extent  is  fire  insurance  subject  to  the  law  of 
decreasing  cost  ? 


viii  CONTENTS 

CHAPTER   III 

PAGE 

THE  BUSINESS  ORGANIZATION  OF  FIRE  INSURANCE    ...      45 

Fire  insurance  as  a  public  and  as  a  private  business. 
Classes  of  private  organizations.  How  a  company  is  organ- 
ized. Importance  of  an  initial  surplus.  Departments  and 
officials  of  a  stock  company.  Character,  success,  and  field 
of  operation  of  Mutual  Companies.  Mutual  and  Stock  Com- 
panies compared.  The  Lloyds.  Inter-insurance  Associa- 
tions. Importance  of  each  class  of  organizations  as  to 
number  and  volume  of  business. 

CHAPTER   IV 

THE  METHOD  OF  TRANSACTING  THE  BUSINESS  OF  FIRE  INSUR- 
ANCE  61 

Departments  of  a  stock  company.  The  importance  of  the 
Home  Office  and  Branch  Offices.  The  examination  of  the 
risk  proposed  by  the  Agent.  The  Field  Force.  The  work 
of  the  early  agents.  Position  of  the  agent  with  respect  to 
the  insurer  and  insured.  The  General  and  the  Special  Agent 
The  formation  of  Unions.  Classification  of  Underwriters 
Associations.  The  Report  of  the  Agent.  The  Broker  and 
the  advantages  and  disadvantages  of  the  Brokerage  System. 
The  process  of  writing  a  risk.  The  problem  of  commissions. 
Flat  and  contingent  commissions.  Board  and  non-board 
companies. 

CHAPTER   V 

THE  HAZARD  IN  FIRE  INSURANCE 84 

Hazard  defined.  The  hazard  in  fire  and  life  insurance  com- 
pared. General  classes  of  hazards.  The  time  and  place  ele- 
ment in  hazard.  Monthly  and  Annual  Fire  Losses.  Periodic 
fluctuations  in  the  loss  ratio.  Physical  hazards,  Construction, 
Occupancy,  Protection,  and  Exposure.  Effect  of  height, 
area,  character  of  roof  and  openings  on  hazard.  Combusti- 
bility and  Damageability.  Public  and  Private  Protection  in 
their  effect  on  hazard.  Radiated,  absorbed,  and  transmitted 
exposure.  The  Conflagration  Hazard  and  its  distribution. 
The  Moral  Hazard.  The  Increase  of  Hazard. 


CONTENTS  ix 

CHAPTER   VI 

FACE 

RATES  AND  RATING 102 

The  rate  defined.  Class  and  specific  rates.  The  rate  in 
its  price  aspect.  Factors  determining  the  rate.  Classifica- 
tion in  relation  to  rates.  The  two  aspects  of  classification.  . 
Rates  in  fire  insurance  and  life  insurance  compared.  Limi- 
tation in  theory  and  practice  of  classification  as  a  basis  of 
rate-making.  Judgment  made  rates.  Schedule  Rating.  Uni- 
versal Mercantile  and  the  Analytical  System.  Method  of 
determining  rates.  Agencies  for  determining  rates.  Public 
and  Private  rate-making.  Rating  Bureaus.  Competition 
in  rate-making  and  its  effects.  Discrimination  in  rates. 
Kinds  and  methods  of  discrimination.  Union  and  non-union 
companies.  Is  fire  insurance  a  public  or  private  business? 
A  competitive  or  monopolistic  business  ?  Public  evils  result- 
ing from  enforcing  competition.  Summary. 

CHAPTER   VII 
THE  POLICY  CONTRACT 139 

The  policy  contract  defined.  Its  indemnity  and  personal 
character.  Its  limitations.  Early  policies.  Influence  of 
English  forms  on  American  fire  insurance  contracts.  Early 
state  requirements  as  to  standard  provisions  in  the  policy. 
The  Development  of  the  Standard  Fire  Insurance  Policy. 
Terms  of  this  policy.  Extent  to  which  these  terms  have  had 
judicial  interpretation.  Explanation  of  the  Standard  Policy 
Riders.  Specific,  Blanket,  Open  and  Floating  Policies.  The 
Use  and  Occupancy  Policy.  Rent  Insurance  Policies.  Lease- 
hold Insurance  Policies.  Profit  Policies.  Automatic  Sprin- 
kler Leakage  Policies. 

CHAPTER  VIII 

THE  Loss  AND  ITS  ADJUSTMENT ;    167 

The  settlement  of  the  loss  as  a  real  test  of  the  contract 
The  loss  settlement  as  a  cause  of  legal  contests.  The  "  con- 
ditions subsequent "  in  the  policy.  Cash  Value  as  the  basis 
of  settlement.  Methods  by  which  the  insurer  may  make  set- 
tlement. Period  for  settlement  How  cash  value  is  to  be 


x  CONTENTS 

PAGE 

determined.  Agreement,  appraisal,  and  acquirement  as  bases 
of  settling  loss  on  contents.  The  work  of  the  adjuster. 
Subrogation  ;  its  basis  in  the  common  law.  When  the  insurer 
becomes  subrogated.  Indemnity  as  the  characteristic  of  the 
fire  insurance  contract.  Court  decisions  on  subrogation  and 
indemnity  as  the  basis  of  the  contract.  Reasons  for  differ- 
ence of  opinion  of  courts. 

CHAPTER  IX 
LIMITATION  OF  LIABILITY  AND  DISTRIBUTION  ....    183 

Clauses  limiting  liability.  Reasons  for  these  limitations. 
The  Three-fourth  Value  Clause.  Its  basis.  The  fire  insur- 
ance rate  as  a  tax.  The  Three-fourth  Loss  Clause.  Valued 
Policy  Laws.  Reasons  for  their  enactment.  The  Co-insur- 
ance Clause.  Its  purpose.  When  it  is  applicable.  Illustra- 
tions of  its  effect.  Results  of  a  failure  to  use  it.  Its 
theoretical  and  practical  justification.  Insurable  interests. 
The  Mortgage  Clause,  and  its  contribution  feature. 

CHAPTER   X 

FINANCES  OF  FIRE  INSURANCE 210 

The  Premium.  The  fire  insurance  and  the  life  insurance 
premium  compared.  Is  the  fire  insurance  premium  the  same 
as  a  tax  ?  Premium  receipt  on  different  classes  of  contracts. 
The  reserve,  its  origin,  and  character.  The  reserve  as  a 
reinsurance  reserve  and  as  an  unearned  premium  income. 
To  what  extent  is  it  an  asset  for  the  company  ?  Uncertainty 
of  the  sufficiency  of  the  reserve  on  single  risks.  Method  of 
calculating  the  reserve.  The  reserve  in  fire  and  life  insur- 
ance. Why  the  prevailing  method  of  calculating  the  reserve 
is  a  disadvantage  to  new  companies.  The  surplus.  Its  ori- 
gin and  purpose.  The  surplus  in  fire  and  life  insurance 
compared.  The  investment  of  fire  insurance  companies. 
State  regulation  of  investments.  The  expenses  of  fire  insur- 
ance organizations.  Analysis  of  character.  Fixed  expenses. 
Causes  for  their  large  amount.  The  explanation  of  the 
increase  in  expenses.  To  what  extent  can  expenses  be  re- 
duced ?  The  importance  of  taxes  as  an  item  in  expenses. 


CONTENTS  xi 

PACK 

Dividends ;  sources,  and  amount.  Underwriting  and  total 
profit.  Have  profits  in  fire  insurance  been  large  ?  Failure 
of  fire  insurance  companies  explained. 


CHAPTER  XI 

FIRE  PREVENTION  AND  THE  FIRE  Loss 245 

Statistics  of  the  fire  loss.  Its  economic  significance.  Ur- 
ban and  rural  losses.  Comparison  with  European  fire  loss. 
Causes  of  the  difference.  Loss  in  different  sections  of  the 
United  States.  The  theory  of  personal  liability  in  the  United 
States  in  its  relation  to  losses  by  fire.  Over-insurance,  ar- 
son, and  incendiarism  in  their  relation  to  the  fire  loss.  Causes 
of  fires.  Agencies  for  preventing  and  controlling  fires.  Pri- 
vate and  Public  Agencies.  Fire-proof  Buildings.  The  work 
of  fire  insurance  organizations  in  preventing  fires.  The  work 
of  the  Laboratory  of  the  National  Board  of  Fire  Under- 
writers. Automatic  Sprinklers.  Their  efficiency.  Building 
codes.  Fire  Marshals.  Fire  Departments  and  Water  Works. 
Fire  Alarm  Systems.  Schedule  Rating  in  its  effect  on  the 
Fire  Loss. 

CHAPTER  XII 
THE  RELATION  OF  THE  STATE  TO  INSURANCE    ....    277 

Character  of  the  insurance  contract  as  a  cause  of  state 
regulation.  Common  fallacies  as  to  insurance.  Is  insurance 
a  public  or  private  business  ?  The  decisions  of  the  Supreme 
Court  as  to  its  public  character.  Is  insurance  a  monopolistic 
business  ?  Effect  of  rate  wars  in  fire  insurance.  Attempts 
to  bring  insurance  under  the  regulation  of  the  Federal  Gov- 
ernment. Early  methods  of  regulating  life  insurance.  Pres- 
ent methods  of  regulation.  How  a  life  insurance  company 
is  organized.  The  examination  of  life  insurance  companies. 
The  liquidation  of  life  insurance  companies  by  the  state. 
Taxation  of  life  insurance  companies.  The  regulation  of  fire 
insurance  companies  centers  about  the  rate  question.  Fire 
insurance  as  affected  by  anti-trust  legislation.  What  authority 
should  make  the  fire  insurance  rate  ?  Discrimination  in  fire 
insurance  rates. 


PRINCIPLES  OF  INSURANCE 

CHAPTER  I 

THE   HISTORICAL   DEVELOPMENT    OF    FIRE   INSURANCE 

Social  Basis  of  Insurance.  —  The  development  of  fire 
insurance  may  be  divided  into  two  periods :  First,  that 
of  informal  organizations,  composed  of  the  mutual  asso- 
ciated efforts  of  groups  and  acts  of  government  which 
from  a  very  early  period  in  the  history  of  human  society 
sought  to  reduce  and  repair  the  damage  occasioned  by 
the  occurrence  of  fire.  This  instinct  of  cooperation  and 
sympathy  for  a  member  of  the  group  suffering  a  loss 
expressed  itself  in  many  forms  in  early  society.  Second, 
that  of  the  business  organization  of  fire  insurance  when 
definite  organizations  either  in  form  of  corporations, 
mutual  associations,  or  individual  business  units  sold 
protection  from  the  damages  incident  to  a  fire  for  a 
price  called  a  premium. 

Conditions  Preventing  Early  Development  of  Insurance. 
—  It  was  not  until  property  was  held  by  a  large  number 
of  the  social  group,  that  is,  not  until  many  different  indi- 
viduals were  directly  affected  by  the  losses  due  to  fire 
that  formal  organizations  could  exist  for  the  purpose  of 
insuring  against  losses  by  fire ;  nor  could  fire  insurance 


2  PRINCIPLES  OF  INSURANCE 

as  a  business  exist  until  there  was  some  understanding  of 
the  causes  of  fires  and  some  perception  of  the  regularity 
of  the  occurrence,  that  is,  of  the  law  of  averages.  Fire 
insurance,  like  all  forms  of  insurance,  is  predicated  upon 
the  regularity  of  recurrent  events.  The  data  for  the 
determination  of  such  a  law  of  averages  were  not  avail- 
able in  the  early  history  of  industrial  society.  Nor  was 
there  a  fund  of  capital  which  could  be  productively 
loaned  to  meet  the  requirements  of  modern  fire  insur- 
ance as  a  business. 

The  essential  features  of  all  insurance  —  foresight 
and  cooperation  —  were  largely  non-existent.  Chance, 
as  the  determining  factor  in  human  affairs,  was  a 
common  belief.  Cooperation  is  powerfully  stimulated 
if  the  individuals  by  whom  it  is  applied  perceive  some 
direct  benefit.  This  was  not  true  in  the  earlier  time 
when  individual  ownership  of  property  was  not  im- 
portant. The  motive  did  not  exist  even  if  the  knowl- 
edge of  the  means  to  apply  insurance  had  been  present. 
Property  was  largely  owned  by  a  minority  of  society, 
and  its  loss  was  not  so  seriously  or  directly  felt,  since 
the  position  of  power  enjoyed  by  the  minority  made  it 
possible  for  them  to  recoup  in  part  or  in  whole  their 
loss  from  the  labor  of  the  dependent  majority. 

It  is  to  be  recognized  that  the  character  of  the  indus- 
trial life  and  the  property  did  much  to  retard  the 
development  of  fire  insurance.  The  industrial  life  was 
simple.  A  large  part  of  the  economic  activities  was 
confined  to  the  pastoral  and  agricultural  industries,  or 
to  other  simple  extractive  industries.  What  manu- 
facturing there  was,  centered  very  largely  in  the  house- 


THE  DEVELOPMENT  OF   FIRE  INSURANCE     3 

hold.  There  were  no  large  factories  with  their  con- 
centration of  large  property  values.  The  merchan- 
dising was  also  of  a  very  simple  character,  usually 
with  no  large  stock  of  goods,  located  at  a  particular 
point.  Society  did  not  in  the  earlier  day  possess  a 
large,  diverse  stock  of  goods  with  large  amounts  located 
at  one  point  and  owned  or  traded  in  by  a  single  individ- 
ual or  firm.  It  is  also  to  be  noted  that  the  earlier  centers 
of  civilization  in  western  Asia  and  southern  Europe  had 
less  need  for  the  continuous  use  of  fire,  and  that  the 
chief  building  material  —  clay  and  stone  —  did  much 
to  reduce  the  danger  of  loss  by  fire.  There  were  no 
furnaces,  electrical  wiring,  matches,  and  the  many  other 
modern  causes  of  fire.  It  is  true  that  the  cities  were 
often  poorly  constructed  from  a  modern  fire  insur- 
ance standpoint,  and  that  there  were  few  modern  fire- 
fighting  devices.  Disastrous  fires  were  therefore  not 
unusual  occurrences.  London  had  had,  for  example, 
disastrous  fires  in  798,  892,  1086,  1212,  before  the 
conflagration  of  1666. 

Precursors  of  Modern  Insurance. —  As  the  industrial 
life  became  more  complex,  as  manufacturing  and  com- 
merce with  its  accompanying  institutions  of  exchange  and 
marketing  developed,  the  need  and  occasion  for  formal 
organizations  to  supply  fire  protection  arose.  Long  be- 
fore the  establishment  of  these  business  organizations, 
many  different  kinds  of  associations  and  activities  existed 
to  prevent  fires,  and  to  assist  those  who  suffered  from 
their  occurrence. 

Magistrates  or  priests  in  very  early  society  were  ac- 
customed to  levy  compulsory  contributions  among  the 


4  PRINCIPLES  OF  INSURANCE 

people  of  a  city  for  the  purpose  of  aiding  those  who  had 
suffered  by  fires.  It  will  be  observed  that  this  was  an 
early  form  of  assessment  insurance  by  the  state  and 
differs  in  its  essentials  from  the  modern  practice  of  Fire 
Insurance  in  that  it  included  all  the  members  of  the 
community.  In  this  respect,  indeed,  it  was  superior 
to  our  present  plan,  since  all  property  owners  do  not 
under  our  present  plan  insure  their  property  and  aid 
in  paying  the  fire  loss  which  in  theory  may  as  well  fall 
on  the  uninsured  as  on  the  insured.  That  is  to  state, 
the  ideal  plan  would  be  to  have  all  property  insured, 
since  all  property  owners  as  well  as  non-property  owners 
are  interested  in  having  property  insured  and  are  bene- 
fited by  the  existence  of  insurance.  This  is  true  in  part 
because  the  non-insured  property  is  better  protected  as 
a  result  of  the  many  activities  of  fire  insurance  com- 
panies, and  organizations,  public  and  private,  which 
endeavor  to  reduce  the  hazard  of  fire.  If  the  state 
should  take  over  the  business  of  fire  insurance,  the 
only  logical  method  of  conducting  it  would  be  the 
compulsory  insurance  of  all  property. 

The  Insurance  Aspect  of  the  Guilds.  —  During  the 
Middle  Ages  the  Guilds  provided  from  the  contribu- 
tions of  their  members  funds  to  repair  the  losses  by  fire 
which  the  members  suffered.  This  was  but  one  of  the 
many  activities  of  these  Guilds,  which  existed  for  the 
mutual  benefit  of  their  members.  For  example,  in  the 
Guild  of  the  Palmers,  established  at  Ludlow  (Hereford- 
shire) in  1284,  an  ordinance  provides  that  "  when  it 
happens  that  any  of  the  brethren  or  sisteren  of 'the 
Guild  shall  have  been  brought  to  such  want  through 


THE  DEVELOPMENT  OF  FIRE  INSURANCE     5 

theft,  fire,  shipwreck,  fall  of  house,  or  any  other  mis- 
hap .  .  .  then  once,  twice,  and  thrice  but  not  a  fourth 
time,  as  much  help  shall  be  given  to  them  out  of  the 
goods  of  the  Guild,  as  the  Rector  and  Stewarts,  having 
regards  to  the  deserts  of  each  and  to  the  means  of  the 
Guild,  shall  order." 

There  is  also  some  evidence  that  these  Guilds  were 
sometimes  formed  or  developed  into  organizations 
whose  chief  purpose  was  the  protection  of  the  members' 
property. 

In  the  fifteenth  century  there  was  found  in  Schles- 
wig-Holstein  an  organization  called  Brandgilden,  which 
probably  developed  from  the  earlier  organization  known 
as  Briiderliche,  which  was  formed  to  protect  in  general 
the  property  of  its  members.  The  Brandgilden  were 
municipal  organizations  interested  in  mutual  fire  in- 
surance protection. 

In  1635  a  petition  was  made  to  King  Charles  I  of 
England  for  authority  to  insure  property  against  fire 
losses  but  there  is  no  record  that  a  patent  was  issued. 

Early  Fire  Insurance  Proposals  in  England.  —  Three 
years  later  another  petition  was  made  to  the  King  for 
letters  patent  for  the  term  of  forty-one  years  to  estab- 
lish a  fire  insurance  organization.  It  was  proposed  to 
insure  houses  within  the  city  of  London  and  its  sub- 
urbs at  a  rate  of  12  pence  per  annum  for  every  house 
yielding  £20  yearly  rental.  Fire  engines  and  watch- 
men were  to  be  provided  for  every  ward  in  the  city, 
as  well  as  reserves  of  water  conveniently  located  for 
use  when  a  fire  occurred. 

• 

The  modern  fire  department,  the  fire  watchman,  the 


6  PRINCIPLES  OF  INSURANCE 

salvage  corps,  and  water  protection  are  suggested  at 
this  early  date.  The  King  referred  the  petition  to 
the  Attorney- General  who  considered  the  propositions 
"  reasonable  if  the  petitioners  according  to  theyre  offer 
be  tyed  to  theyre  limitations  and  that  no  man  be  pressed 
to  come  in  to  subscribe  but  every  man  left  to  his  vol- 
untary choyce." 

In  the  petition,  the  proposer  had  agreed  to  deposit 
£5000  with  the  government,  which  should  be  increased 
until  it  amounted  to  £10,000.  This  sum  was  to  be  held 
by  the  government  and  be  invested  by  it  so  as  to  earn 
£5  on  the  £100.  This  was  a  forerunner  of  the  present 
deposit  required  of  stock  fire  insurance  companies  by 
the  state  to  guarantee  the  loss  payments.  The  peti- 
tioners had  also  suggested  compulsory  insurance,  hence 
the  modification  suggested  in  this  particular  by  the 
Attorney- General.  The  King  granted  the  petition  and 
ordered  the  Attorney- General  to  prepare  a  bill,  grant- 
ing the  desired  privileges. 

The  contest  between  Charles  I  and  Parliament  was 
probably  responsible  for  the  failure  of  the  proposal. 
After  Charles  II  ascended  the  throne,  a  proposal  was 
made  to  him  for  the  formation  of  a  fire  insurance  or- 
ganization. The  king  favored  the  project  and  recom- 
mended it  to  the  consideration  of  the  common  council 
of  London.  The  council  rejected  the  proposal  "  because 
they  thought  it  unreasonable  for  private  persons  to 
manage  such  an  undertaking,  or  that  any  one  but  the 
city  should  reap  the  profits  of  the  enterprise."  It  will 
be  observed  that  this  was  an  early  expression  of  the 
belief  in  government  insurance,  which  in  the  United 


THE  DEVELOPMENT  OF   FIRE  INSURANCE     7 

States  has  only  of  late  years  been  a  subject  for  general 
discussion. 

On  the  continent  there  had  existed  organizations  for 
protecting  property  against  fire.  In  1753  there  was 
published  in  Hamburg  an  essay  on  Insurance  by  one 
Magens  in  which  it  is  stated  that  a  "  Fire  Casse  "  had 
long  existed  in  that  city,  which  insured  the  principal 
houses  to  the  value  of  15,000  marks  "  to  be  paid  in 
case  of  their  being  burnt." 

The  great  London  fire  of  1666,  which  destroyed  over 
eighty  per  cent  of  the  buildings  in  London,  did  much 
to  accelerate  the  development  of  fire  insurance  as  a 
business  in  England.  Immediately  after  this  destruc- 
tive fire  many  different  proposals  were  advanced  for 
insuring  houses. 

Dr.  Nicholas  Barbon,  who  had  been  "  a  leading  builder 
of  the  city  of  Lond,"  opened  in  1667  an  office  for  in- 
suring houses  and  buildings.  This  was  a  system  of 
individual  underwriting  and  was  similar  to  that  which 
already  existed  in  marine  and  life  insurance,  especially 
in  the  case  of  marine  insurance.  Individual  under- 
writing at  this  time  was  quite  possible,  owing  partly  to 
the  difference  in  the  amount  of  the  premium  received 
at  that  time  in  comparison  with  the  small  premiums 
now  received.  The  amount  insured  on  each  risk  was 
also  usually  small. 

Many  plans  for  insuring  property  were  laid  before 
the  Council  of  London  with  a  view  of  having  the  city 
assume  this  work.  In  1681  the  city  council  resolved 
"  to  undertake  ye  insuring  of  all  Houses  within  the 
city  and  Liberty es." 


8  PRINCIPLES  OF  INSURANCE 

In  the  meantime  Barbon  and  some  associates  had 
organized  in  1680  a  joint  stock  corporation,  known  as 
the  Fire  Office,  with  a  capital  stock  of  £40,000.  The 
premiums  were  based  upon  the  rental  value  of  the 
property;  and  on  frame  houses  the  rates  were  double 
those  on  brick,  thus  illustrating  one  of  the  earliest 
examples  of  schedule  rating,  although  only  the  con- 
struction feature  of  the  hazard  was  considered. 

Early  Discussion  of  Public  versus  Private  Fire  ln-\ 
surance.  —  When  the  city  of  London  decided  in  1681 
to  insure  property,  discussion  arose  in  respect  to  the 
merits  of  public  and  private  insurance.  Broadsides 
appeared,  and  the  newspapers  contained  numerous  dis- 
cussions of  the  subject.  The  Fire  Office  issued  a  pam- 
phlet of  "  Enquiry  whether  it  be  to  the  interest  of  the 
city  to  insure  houses  from  Fire;  and  what  advantage 
the  insured  may  expect  more  than  from  the  Insurance 
Office  already  settled."  Many  phases  of  the  discus- 
sion are  similar  to  those  of  the  present  day  in  reference 
to  the  respective  merits  of  state  and  private  insurance. 
The  city  of  London  retired  from  this  particular  ven- 
ture after  a  year's  experience.  The  Fire  Office  con- 
tinued in  business  and  in  time  came  to  be  known  as 
the  Phcenix  Office  from  its  badge  of  a  Pho3nix  in  the 
flames. 

Mutual  versus  Stock  Insurance.  —  Soon,  however, 
this  private  corporation  was  to  have  a  competitor. 
In  1683  a  proposal  was  issued  "  for  securing  Houses 
from  any  considerable  Loss  by  Fire,  by  Way  of  Sub- 
scription and  Mutual  contribution."  This  was  the  first 
of  the  Friendly  societies  and  the  real  beginning  of 


THE  DEVELOPMENT  OF  FIRE  INSURANCE  9 

mgdern  mutual_frrfi  ipgm-aru*»  It  will  be  understood 
from  the  preceding  descriptions  that  the  mutual  prin- 
ciple of  protecting  members  of  a  social  group  against  the 
losses  due  to  fire  had  long  existed.  But  the  mutual 
organizations  which  were  now  to  be  formed  were  char- 
acterized by  more  formal  organization  with  specific 
duties  and  privileges  on  the  part  of  its  members.  Each 
member  of  this  Friendly  Society  agreed  when  they 
joined  to  pay  not  to  exceed  30$.  for  every  £100  of  insur- 
ance. This  sum  was  to  remain  in  the  members'  pos- 
session, except  that  6s.  Sd.  of  every  305.  should  be  paid 
in  as  a  pledge  and  at  the  expiration  of  the  insurance 
was  to  be  returned  to  the  member.  In  addition  each 
member  was  to  pay  is.  ^d.  for  every  £100  of  insurance 
for  the  expenses  of  administering  the  Society.  Some 
mutual  association  of  a  later  day  which  made  inade- 
quate provision  for  loss  payments  and  expenses  might 
well  have  taken  a  lesson  from  the  plans  of  this  early 
mutual  company.  There  arose  at  once  a  discussion 
between  the  private  joint  stock  company,  —  the  Fire 
Office,  —  and  the  Friendly  Society,  as  to  the  respective 
merits  of  the  plans.  Dr.  Barbon  argued  that  there 
could  be  "  no  insurance  unless  there  be  a  fund  settled 
that  is  both  certain  and  able  to  make  good  the  loss." 
Whereupon  the  Friendly  Society  replied  that  "  the 
Fund  in  the  Fire  Office  is  neither  greater  nor  the  Insur- 
ance cheaper  than  in  the  Friendly  Society."  The  Fire 
Office  officials  appealed  to  the  Crown  for  an  order  to 
compel  the  Friendly  Societies  to  cease  writing  insur- 
ance, and  after  much  discussion  the  society  was  ordered 
to  refrain  for  a  year  from  insuring  property.  After 


io  PRINCIPLES  OF   INSURANCE 

obtaining  Letters  Patent  the  Society  could  operate 
every  alternate  three  months.  The  Fire  Office  thus 
obtained  practically  for  a  time  a  monopoly.  However, 
other  organizations  were  soon  formed  both  of  a  private 
and  of  a  mutual  character,  so  that  the  old  Fire  Office 
soon  had  considerable  competition. 

Early  English  Companies.  —  In  1710  Charles  Povey, 
who  as  early  as  1706  was  underwriting  and  issuing  fire 
insurance  policies,  organized  the  company  of  London 
Insurers,  although  the  company  was  partly  formed  in 
1709.  This  organization  soon  came  to  be  known  as 
The  Siy^  Firp  Offlrp  for  insuring  Houses,  Goods,  Wares, 
and  MerchandfsFlrom  Loss  and  Damage  by  Fire.  Thus 
was  established  one  of  the  oldest  of  present  fire  insurance 
companies,  and  it  is  to  be  noted  that  it  insured  goods, 
wares,  and  merchandise.  The  earlier  companies  had 
confined  their  activities  to  houses  and  buildings.  This 
Sun  Company,  named  such  because  of  its  use  of  a  sun 
as  a  sign,  wrote  policies  in  the  cities  and  towns  of  Great 
Britain,  whereas  other  companies  had  confined  their 
business  to  a  more  limited  territory.  Separate  policies 
were  required  for  houses  and  goods.  The  policies  were 
in  effect  when  signed  by  three  or  more  members  of  the 
company  of  the  insurers.  No  policy  was  for  a  greater 
sum  than  £500,  but  no  guarantee  was  given  that  losses 
to  this  amount  would  be  paid.  The  payment  depended 
upon  the  amount  of  available  funds.  This  fund  orig- 
inated from  a  payment  by  each  policyholder  of  35.  per 
quarter  after  the  first  quarter,  when  the  payment  was 
4$.,  the  one  shilling  being  for  the  stamp  tax.  One  shil- 
ling was  reserved  out  of  each  quarter's  payment  to 


THE  DEVELOPMENT  OF  FIRE   INSURANCE    n 

constitute  a  fund,  and  within  ten  days  of  the  close  of 
each  quarter  all  moneys  so  reserved  were  divided  among 
the  sufferers  in  proportion  to  their  respective  losses,  not 
exceeding  £500  on  each  policy.  The  articles  in  the 
agreement  of  this  early  organization  contained  many  of 
the  provisions  of  present  policy  contracts,  such  as 
notice  and  sworn  statement  of  losses,  and  change  of 
residence.  The  similarity  of  present  fire  and  marine 
insurance  policies  to  those  of  an  early  date  is  much 
greater  than  that  of  life  insurance  policies. 

In  1696  there  had  been  formed  a  purely  mutual  or- 
ganization, the  Amicable  Contributors  for  Insuring 
from  Loss  by  Fire,  which  soon  came  to  be  known  as  the 
Hand-in-Hand.  This  society  confined  its  insurance  at 
first  to  Houses  and  Buildings.  In  1714  another  mu- 
tual society,  the  Union  or  Double  Hand-in-Hand,  was 
formed,  which  insured  the  contents  of  buildings,  thus 
supplementing  the  activities  of  the-  older  Hand-in- 
Hand  Society.  Thus  it  will  be  observed  that  before 
the  close  of  the  first  quarter  of  the  eighteenth  century, 
all  the  present-day  types  of  fire  insurance  organizations 
were  in  existence,  with  the  possible  exception  of  the 
special  mutuals,  such  as  Factory  Mutuals  and  other 
mutuals  insuring  risks  in  a  single  industry  or  business. 
That  is,  the  stock  plan,  the  mutual  plan,  private  insur- 
ance and  public  insurance  had  been  tried.  Competi- 
tion, as  is  the  case  at  present,  was  keen  between  the 
stock  and  mutual  organizations.  Each  endeavored  by 
pamphlets,  broadsides,  and  other  methods  to  prove  the 
superiority  of  their  plan. 

The  Bubble  Period  and  Fire  Insurance.  —  The  period 


12  PRINCIPLES  OF  INSURANCE 


speculation,  exemplified  in  the  South  Sea  Bubble 
and  other  similar  ventures,  had  its  effect  on  the  devel- 
opment of  fire  insurance.  Marine  and  life  insurance 
were  first  used  as  a  basis  of  such  speculative  ventures, 
but  by  1720  similar  organizations  were  based  upon  fire 
insurance.  Companies  were  proposed  with  capital  of 
£2,000,000,  representing  an  enormous  amount  of  capital 
for  this  time  ;  many  shares  of  stock  were  sold  ;  the  pur- 
chasers, as  in  the  case  of  most  of  the  other  speculative 
companies  of  the  period,  often  received  no  return.  A 
pack  of  playing  cards  issued  during  the  period  with  a 
verse  on  each  card  sets  forth  the  follies  of  the  period. 
The  seven  of  clubs  expressed  the  spirit  of  the  times  in 
reference  to  fire  insurance  in  the  following  words  : 

Projecting  sure  must  be  a  gainful  trade, 
Since  all  the  elements  are  bubbles  made. 
They're  right  that  gull  us  with  the  dread  of  fire 
For  fear  makes  greater  fools  than  fond  desire. 

However,  other  companies  of  the  best  character  were 
being  formed.  The  Royal  Exchange  and  the  Cor- 
poration of  London  Assurance  were  chartered  in  1721, 
although  the  former  did  not  place  its  fire  division  in 
operation  until  a  year  later.  Older  organizations  were 
changing  their  plans  to  meet  the  developing  conditions. 
The  Sun  provided  a  regular  joint  stock  plan  which 
would  produce  a  fund  to  guarantee  the  payment  of  its 
policies,  and  the  London  Assurance  Corporation  en- 
larged its  classification  of  risks.  However,  of  the 
twenty-one  important  companies  formed  between  the 
opening  of  Dr.  Barbon's  office  in  1667  to  the  formation 


THE  DEVELOPMENT  OF  FIRE  INSURANCE    13 

of  the  Liverpool  Company  in  1777,  only  nine  existed 
in  1780.  Among  the  more  important  companies  of 
these  nine,  the  following,  with  their  dates  of  organ- 
ization, may  be  noted :  the  Hand-in-Hand,  1696 ; 
the  Sun,  1710;  the  Union,  1714;  the  London  As- 
surance Corporation,  1721 ;  the  Royal  Exchange,  1721 ; 
and  the  Liverpool,  1777. 

In  1782,  under  the  premiership  of  Lord  North,  the 
first  regular  tax  on  fire  insurance  was  levied.  This  was 
a  percentage  duty  on  the  sum  insured. 

Some  of  the  English  companies  had  by  the  close  of 
the  century  opened  offices  on  the  Continent  and  in  the 
United  States,  and  by  the  middle  of  the  following  cen- 
tury they  had  property  insured  in  the  United  Kingdom 
to  the  extent  of  half  a  billion  pounds. 

It  has  seemed  advisable  to  devote  the  chief  part  of 
the  discussion  to  the  earlier  history  of  fire  insurance 
for  the  following  reasons : 

First,  modern  fire  insurance  had  its  genesis  in  Great 
Britain,  and  the  development  in  the  United  States  has 
been  in  many  respects  similar  to  that  in  England. 

Second,  in  the  early  period  practically  all  the  present 
forms  of  fire  insurance  organizations  existed. 

Third,  no  organizations  of  any  country  operate  over 
such  a  great  part  of  the  world  as  the  companies  of  Great 
Britain.  Their  business  is  world-wide,  a  natural  result 
of  the  extensive  trade  of  England  and  the  wide  distri- 
bution of  her  domain  and  property  of  a  movable  char- 
acter. 

Early  Insurance  Organizations  in  United  States  and 
England.  —  In  the  history  of  fire  insurance  development 


i4  PRINCIPLES  OF  INSURANCE 

in  the  United  States  there  are  many  points  of  similarity 
to  its  development  in  Great  Britain.  Early  companies 
were  patterned  after  those  of  England  and  in  a  number 
of  cases  adopted  the  names  of  the  older  English  com- 
panies. Some  of  the  more  important  English  com- 
panies opened  offices  in  this  country  and  continue  to 
the  present  time  to  have  a  large  amount  of  insurance 
in  the  United  States.  In  colonial  days  the  condition 
of  the  country  precluded  any  considerable  development 
of  fire  insurance.  Property  values  were  small  and 
with  the  exception  of  that  employed  in  commerce  were 
not  of  large  amount  in  any  one  industry  or  at  any  one 
point.  Population  was  sparse  and  widely  distributed 
over  a  large  area  with  little  concentration  of  property 
values.  The  colonists  largely  relied  upon  mutual  aid 
in  case  of  fire,  since  force  of  circumstances  produced 
a  considerable  amount  of  cooperation.  The  loss  of  the 
early  settler's  property,  though  often  serious,  produced 
no  such  important  results  as  the  loss  of  an  individual's 
property  does  at  present.  This  was  largely  due  to  the 
fact  that  few  of  them  had  a  complex  stock  of  goods  and 
tools.  Much  of  what  they  had  could  be  replaced. 
The  house  could  by  the  cooperation  of  the  neighbors 
often  be  restored  from  the  abundant  building  material 
at  hand.  There  was  little  accumulated  capital  to 
form  stock  fire  insurance  companies  or  to  pay  premiums, 
partly  due  to  the  depletion  of  the  little  wealth  by  the 
Revolutionary  War  and  other  wars,  but  largely  due  to 
the  newness  of  industrial  activity.  There  was  a  limited 
amount  of  individual  underwriting  in  the  form  of  per- 
sonal ventures  similar  to  those  which  had  existed  in 


England.  This  was  especially  true  in  the  case  of  marine 
insurance,  for  this  form  of  insurance  was  the  first  to 
develop  to  any  considerable  importance  in  this  coun- 
try. This  was  due  to  the  relatively  greater  importance 
of  ship  building  and  the  carrying  trade  in  the  early  in- 
dustrial history  of  the  United  States.  Some  of  this 
early  marine  insurance  business  was  written  by  the 
English  companies  and  some  by  private  underwriters 
in  this  country.  Along  the  Atlantic  seaboard,  especially 
in  the  New  England  States,  the  early  development  of 
the  carrying  trade  brought  a  need  for  marine  insurance. 
Character  of  Early  Companies  in  United  States.  — 
In  1794  the  Insurance  Company  of  North  America  was 
incorporated,  and  in  the  same  year  the  Insurance  Com- 
pany of  the  state  of  Pennsylvania.  The  chief  business 
of  these  companies  was  at  first  marine  insurance,  al- 
though the  former  soon  began  to  write  fire  insurance 
on  houses  and  goods.  It  is  interesting  to  note  that  the 
rate  on  brick  houses  was  thirty  cents  per  hundred  for  an 
eight-thousand  dollar  policy  when  insured  for  its  full 
value.  The  rates  increased  for  a  larger  amount  of 
insurance.  The  rate  on  frame  houses  was  seventy-five 
cents  per  hundred.  The  Philadelphia  Contribution- 
ship  had  been  formed  in  1752  as  a  fire  insurance  organi- 
zation. It  adopted  the  plans  of  the  English  company, 
the  Hand-in-Hand.  The  Philadelphia  Contribution- 
ship  refused  to  insure  houses  with  trees  in  front  of 
them,  thus  beginning  a  classification  of  hazards.  Largely 
for  this  reason  the  Mutual  Assurance  Company  was 
formed  in  1784.  It  adopted  for  its  sign  a  green  tree. 
In  1794  the  Baltimore  Equitable  Society  was  formed. 


16  PRINCIPLES   OF   INSURANCE 

Each  of  these  three  companies  conducted  their  business 
on  the  plan  of  perpetual  insurance,  that  is,  the  single 
payment  of  such  a  part  of  the  face  of  the  policy  as  will 
by  its  annual  interest  earnings  amount  to  a  sufficient 
fund  to  pay  all  the  annual  losses.  It  is  similar  to  the 
principle  of  the  annuity  in  life  insurance,  since  instead 
of  annual  payment  to  secure  a  stated  sum  in  the  event 
of  a  loss,  a  larger  bulk  sum  is  paid  once  for  all  in  lieu  of 
the  annual  payments. 

The  Mutual  Insurance  Company  of  New  York,  later 
called  the  Knickerbocker,  was  organized  in  1787,  and 
in  1806  the  Eagle  Fire  Insurance  Company,  with  a  capital 
of  $500,000,  was  formed.  The  companies  formed  in  the 
different  states  in  the  early  period  were  primarily  in- 
terested in  marine  insurance.  They  were  incorporated 
usually  by  special  acts  of  the  legislatures  and  in  most 
cases  were  granted  charters  only  for  a  period  of  years, 
as,  for  example,  a  period  of  twenty  or  thirty  years. 

Importance  of  Marine  Insurance.  —  The  merchants 
of  the  New  England  States,  especially  those  of  Massa- 
chusetts and  Connecticut,  were  on  acccount  of  their 
business  much  interested  in  marine  insurance.  Some 
of  these  were  individual  underwriters,  others  formed 
copartnerships,  and  in  time  separate  corporations 
were  formed  to  transact  an  insurance  business,  chiefly 
marine  insurance.  The  Hartford  Insurance  Company 
was  organized  in  1803  to  transact  a  marine  business. 
The  capital  was  $80,000,  divided  into  $4o-shares.  The 
war  of  1812  and  the  events  leading  up  to  it,  especially 
the  Embargo  and  Non-intercourse  Acts,  had  a  disastrous 
effect  upon  the  shipping  and  trading  of  the  United 


THE  DEVELOPMENT  OF   FIRE  INSURANCE     17 

States.  This  caused  many  of  the  marine  insurance 
companies  in  the  United  States  to  fail.  Others  were 
saved  from  failure  by  changing  their  business  to  fire 
insurance.  The  Hartford  Fire  Insurance  Company, 
one  of  the  largest  and  oldest  companies  now  doing 
business,  was  organized  in  1810.  This  was  a  stock  cor- 
poration, and,  like  most  of  such  companies  formed  in 
the  early  period,  had  only  a  small  part  of  its  capital 
stock  paid  in  cash.  Notes  and  mortgages  of  the  sub- 
scribers to  the  stock  were  taken  in  lieu  of  cash.  The 
^Etna,  another  large  and  old  company  of  the  present, 
was  organized  in  1819.  Its  capital  was  $150,000. 

These  early  fire  insurance  companies  had  little  ac- 
curate data  upon  which  to  base  premium  rates.  It  is 
true  the  English  and  continental  European  companies 
had  been  transacting  fire  insurance  for  a  number  of 
years,  but  their  rates  and  experience  were  only  of  general 
value  to  the  American  companies.  The  hazard  or  risk  in 
fire  insurance  is  quite  different  from  that  in  lif e  insurance 
since  it  is  a  resultant  of  many  complex  factors.  The.  con- 
struction, the  protection,  the  business  carried  on  in  the 
building,  the  climatic  conditions,  and  many  other  fac- 
tors, varying  not  only  from  country  to  country  but  also 
from  risk  to  risk,  affect  the  particular  rate  to  be  charged. 
These  early  fire  companies  could  not  therefore  rely  upon 
the  European  rates  as  could  the  life  companies.  There 
was  a  large  element  of  risk  for  the  incorporators  of  these 
early  companies. 

The  officials  of  the  company  in  the  early  days  did 
much  of  the  work  which  is  now  intrusted  to  experts 
and  supplementary  organizations.  The  board  of  di- 


i8  PRINCIPLES  OF  INSURANCE 

rectors  passed  upon  the  risk,  and  with  the  other  officers 
spent  much  time  in  traveling  to  inspect  properties  and 
to  appoint  agents. 

Early  Foreign  and  Domestic,  Stock  and  Mutual, 
Companies.  —  Previous  to  1800  there  had  been  or- 
ganized in  the  United  States  about  ten  mutual,  and 
four  stock,  companies,  but  by  1820  the  latter  class  of 
companies  had  increased  to  twenty-six.  Partly  as  a 
result  of  the  ill  feeling  engendered  by  the  war  of  1812, 
and  partly  as  a  result  of  the  increasing  number  of  do- 
mestic companies,  statutes  were  enacted  in  some  of  the 
states,  especially  in  New  York  and  Pennsylvania,  pro- 
hibiting foreign  companies  from  writing  insurance. 
New  York  and  Pennsylvania  were  the  home  states  of 
the  largest  number  of  American  companies.  These 
prohibitory  statutes  continued  in  force  in  most  states 
until  the  New  York  fire  of  1835  compelled  their  repeal 
in  order  to  secure  for  property  owners  sufficient  insur- 
ance, since  many  of  the  domestic  companies  failed  as  a 
result  of  this  fire. 

The  New  York  Fire  and  Fire  Insurance.  —  The  date  of 
this  New  York  fire  (1835)  may  be  considered  as  closing 
the  first  period  in  the  development  of  fire  insurance  in  this 
country.  It  was  a  period  of  experimentation.  As  the 
industrial  life  developed  and  property  values  increased, 
fire  insurance  began  to  be  appreciated  more  for  the 
service  it  could  render,  and  the  increasing  wealth  of  the 
people  made  it  easier  for  them  to  purchase  insurance. 
Both  stock  and  mutual  companies  were  organized, 
with  the  former  of  growing  importance  in  respect  to  the 
volume  of  property  insured.  The  spirit  of  mutual  help- 


THE  DEVELOPMENT  OF  FIRE  INSURANCE    19 

fulness,  characteristic  of  all  pioneer  civilizations,  often 
replaced  the  neighbor's  house  or  barn  and  thus  sup- 
plemented the  work  of  the  formally  organized  stock 
and  mutual  companies. 

The  New  York  fire  was  productive  of  several  im- 
portant results.  In  the  first  place,  the  failure  of  so 
many  companies  led  to  a  demand  that  the  state  take 
action  to  compel  the  companies  to  maintain  funds  which 
would  guarantee  the  payment  of  the  policies.  In  1837 
Massachusetts  passed  a  law  requiring  companies  to 
accumulate  such  a  fund.  This  may  be  considered  as 
the  first  of  the  unearned  premium  laws,  that  is,  a  setting 
aside  of  a  part  of  the  premiums  in  a  reserve  fund. 

In  the  second  place  it  directed  more  careful  atten- 
tion to  the  rates  which  had  been  charged.  There  had 
been  little  classification  of  risks,  and  the  experience  was 
not  analyzed  to  discover  whether  the  rates  on  a  particu- 
lar type  of  building  or  class  of  property  were  too  low  or 
too  high.  In  the  third  place  this  fire  impressed  the 
companies  with  the  necessity  of  accumulating  a  surplus 
to  meet  unexpected,  large  losses,  for  no  statutory  re- 
quirement later  enacted  or  now  in  force  would  provide 
funds  sufficient  to  pay  for  the  possible  losses  resulting 
from  conflagrations. 

New  York  in  1853  enacted  a  law  which  required  a 
company  to  keep  from  30  to  60  per  cent  of  the  unex- 
pired  or  unearned  premiums  in  a  reinsurance  fund. 
This  was  supposed  to  be  such  a  fund  which  thus  ac- 
cumulated would  be  sufficient  to  reinsure  the  risk  in 
another  company,  if  any  particular  organization  de- 
sired to  go  out  of  business.  Other  states  followed  the 


20  PRINCIPLES  OF  INSURANCE 

example  of  Massachusetts  and  New  York,  and  although 
there  was  considerable  legislation  proposed  during  this 
period,  it  was  not  until  after  the  Civil  War  that  any 
important  legal  restrictions  and  control  was  placed 
upon  fire  insurance  companies.  Charters  of  incor- 
poration were  easily  secured  and  were  liberal  in  their 
terms. 

A  fourth  result  of  this  New  York  fire  was  the  impetus 
given  to  the  organization  of  mutual  companies.  Since 
many  of  the  stock  companies  had  failed,  the  people  not 
unnaturally  reasoned  that  they  might  well  provide  their 
own  insurance.  In  1853,  sixty-two  mutual  companies 
were  reporting  to  the  New  York  comptroller.  These 
mutual  companies  made  the  mistake  of  attempting  to 
cover  the  large  field  of  the  former  stock  companies  in- 
stead of  confining  themselves  to  a  restricted  area.  As  a 
result  many  of  them  were  short-lived,  and  the  losses 
to  the  members  were  very  great.  Between  1849  and 
1853  there  was  organized  in  New  York  alone  fifty-four 
mutual  companies,  but  of  these  only  seven  were  in 
business  in  1860.  There  have  been  these  alternate 
periods  of  promotion  and  failure  of  the  mutual  plan  of 
fire  insurance,  but  it  is  safe  to  state  on  the  basis  of  many 
years'  experience  that  the  mutual  plan  of  fire  insurance 
is  limited  to  two  types  of  organizations  for  successful 
operation ;  first,  to  the  insuring  of  like  property  in  a 
restricted  area,  such  as  farmhouses  and  outbuildings; 
second,  to  the  insuring  of  like  property  of  a  single  busi- 
ness, such  as  factories  engaged  in  manufacturing  similar 
goods,  where  there  is  good  construction,  inspection, 
protection,  and  use  of  the  property. 


THE  DEVELOPMENT  OF  FIRE   INSURANCE     21 

Notwithstanding  the  prevalence  of  mutual  com- 
panies, stock  fire  insurance  began  to  recover  from  the 
effects  of  this  New  York  fire.  New  companies  were 
organized  to  meet  the  increasing  demands  of  a  rapidly 
developing  industrial  life. 

The  policy  was  improved,  and  greater  uniformity 
resulted.  The  agency  force  was  more  carefully  selected, 
and  the  agents  began  to  form  local  organizations.  Special 
agents,  or  field  men  as  they  were  called,  were  appointed. 
Losses  were. more  promptly  settled.  Risks  were  more 
carefully  inspected.  Fire  insurance  was  rapidly  be- 
coming a  business. 

The  one  most  serious  and  weakest  aspect  of  the 
business  was  the  excessive  competition  among  the  in- 
creasing number  of  companies  for  the  rapidly  increasing 
properties  to  be  insured. 

The  National  Board  of  Fire  Underwriters.  —  The 
beginning  of  the  third  period  may  be  dated  from  1866, 
when  the  National  Board  of  Underwriters  was  formed 
for  the  purpose  of  securing  some  measure  of  cooperation 
among  these  strongly  competing  companies.  This 
board  did  much  to  unify  rates  during  the  next  ten  years, 
but  in  1877  the  making  of  rates  was  again  referred  to 
the  local  boards.  This  introduced  another  period  of  ex- 
cessive competition  with  its  consequent  cutting  of  rates 
until  in  the  eighties,  when  the  subject  of  rate-making 
was  assumed  by  various  territorial  underwriters'  associ- 
ations, made  up  largely  of  the  field  men  of  the  leading 
companies.  These  organizations  came  to  be  called 
Unions,  and  as  such  they  exist  at  present,  although  much 
of  the  direct  work  of  making  rates  has  been  assumed  by 


22  PRINCIPLES  OF  INSURANCE 

independent  associations,  such  as  rating  or  inspection 
bureaus. 

In  addition  to  the  constructive  work  of  the  National 
Board  of  Underwriters  other  improvements  were  made 
soon  after  the  opening  of  this  third  period.  The  daily 
report,  first  used  in  1867,  was  improved,  and  this  tended 
to  an  improvement  of  the  business,  both  because  of  a 
closer  relationship  between  the  agent  and  the  company 
and  also  because  the  risks  were  more  carefully  selected. 
In  these  daily  reports  the  agents  transmitted  to  the 
general  office  a  detailed  report  on  the  risk  insured. 
The  company  examined  the  report  and  if  the  risk  was 
not  acceptable  for  any  reason,  it  ordered  the  agent  to 
cancel  the  policy  which  had  already  been  issued.  A 
greater  number  of  special  agents  were  appointed  and 
their  duties  of  inspecting  the  more  important  risks, 
counseling  with  local  agents  and  appointing  new  ones, 
were  emphasized. 

The  Fire  Map  and  the  Standard  Policy.  —  The  Fire 
Map  came  into  more  general  use.  These  maps  showed 
for  the  more  important  cities  and  towns  all  the  impor- 
tant facts  affecting  a  risk,  such  as  the  width  of  the 
streets,  the  location  of  water  plugs,  the  height  of  the 
buildings,  the  thickness  of  the  walls,  the  location  of 
windows,  doors,  and  other  openings.  So  complete  in 
detail  have  these  maps  become  that  one  can  often  secure 
more  information  concerning  a  building  by  a  reference 
to  these  maps  than  he  could  by  an  ordinary  inspection 
of  the  building.  They  are  continually  revised  and 
every  important  change  in  the  risk  is  noted.  They  are 
of  incalculable  value  in  the  conducting  of  modern  fire 


THE   DEVELOPMENT  OF   FIRE   INSURANCE     23 

insurance.  They  serve  as  a  basis  of  examining  the 
daily  reports,  forwarded  to  the  company  by  the  agents. 
The  company  can  determine  from  their  'examination 
the  character  of  the  proposed  risk,  the  amount  of  in- 
surance already  written  in  a  particular  section  of  a 
city,  and  many  other  facts  of  importance  in  deciding 
upon  the  acceptance  or  rejection  of  the  risk. 

Another  important  development  of  this  period  was 
the  adoption  of  a  standard  form  of  a  fire  insurance 
policy.  This  was  done  by  New  York  in  1886  as  the 
result  of  the  work  of  a  joint  committee  of  insurance 
men,  working  in  cooperation  with  representatives  of 
the  state. 

This  standard  policy  of  New  York  State  was  adopted 
in  many  other  states,  and  when  not  adopted  as  a  whole 
by  a  few  states,  such  slight  modifications  were  made  as 
to  bring  general  uniformity  into  the  fire  insurance 
policy.  Previous  to  this,  the  policies  of  different  com- 
panies varied  considerably,  both  as  to  companies  and 
sections  of  the  country.  Confusion  frequently  re- 
sulted. The  liability  of  the  company  and  the  rights  of 
the  policyholder  were  often  difficult  to  determine. 

Other  Factors  in  the  Development  of  Fire  Insurance. 
—  Among  other  important  facts  in  the.  historical  de- 
velopment of  fire  insurance  in  the  United  States  may 
be  mentioned  the  following,  which  will  be  discussed  in 
detail  in  succeeding  chapters : 

(a)  The  development  of  the  inspection  work.  As 
has  been  stated,  there  was  little  or  no  careful  inspection 
of  the  risk.  The  officers  of  the  company  examined  the 
application,  and  as  the  business  of  the  early  companies 


24  PRINCIPLES  OF  INSURANCE 

was  at  first  restricted  as  to  amount  and  territory,  these 
officials  usually  had  fairly  satisfactory  knowledge  of 
the  property  and  its  owner.  In  tune,  however,  the 
business  was  extended  to  more  distant  territory  and 
agents  were  appointed  upon  whose  information  the 
company  had  to  rely  in  determining  the  acceptance  of 
the  risk.  Field  men  and  special  agents  were  appointed, 
and  they  did  some  of  the  work  of  inspecting  the  im- 
portant risks  and  the  agent;  that  is,  they  appointed 
the  agent  and  visited  him  from  time  to  time,  thus  se- 
curing a  knowledge  of  his  character  and  his  business 
ability. 

Fire  maps  came  into  use  in  time,  and  these  greatly 
aided  the  company  in  determining  its  acceptance  and 
rejection  of  the  risk. 

The  last  stage  in  the  evolution  of  the  inspection  work 
came  when  the  inspection  was  done  by  special  bureaus, 
usually  independent  of  the  companies.  It  is  important 
to  understand  th£  significance  of  this  inspection  work 
in  its  relation  to  fire  insurance.  The  fire  insurance 
agent  secures  the  business  and  places  the  policy  in 
force.  He  is  often  a  representative  of  several  com- 
panies. When  he  reports  that  a  particular  property 
has  been  insured,  the  company  must  decide  if  it  wishes 
the  risk  and  also  whether  the  rate  charged  is  satisfactory. 

The  inspection  work,  therefore,  lies  at  the  foundation 
of  the  rate  structure.  It  is  also  an  important  factor  in 
preventing  fires  and  reducing  the  fire  loss. 

(&)  The  development  of  schedule  rating.  In  the 
early  days  of  fire  insurance,  risks  were  divided  into  two 
general  classes,  brick  and  frame.  No  attempt  was 


THE  DEVELOPMENT  OF  FIRE  INSURANCE     25 

made  to  classify  risks  more  minutely  and  analyze  the 
different  elements  in  the  hazard.  From  this  simple  situ- 
ation there  has  developed  a  very  detailed  and  complex 
method  of  rating  risks. 

(c)  The  development  of  the  regulation  of  fire  insur- 
ance by  the  state  legislatures.  It  has  been  stated  that 
in  the  early  stages  of  the  business,  special  charters  were 
granted  for  the  organization  of  companies  and  often 
the  charter  was  granted  for  a  limited  number  of  years. 
These  charters  were  freely  granted  and  usually  upon 
such  terms  as  the  incorporators  desired.  There  were 
no  statutory  requirements  of  any  importance,  guaran- 
teeing the  solvency  of  the  companies.  Massachusetts 
in  1837  enacted  a  reinsurance  reserve  law  and  New 
York  in  1853  also  passed  an  unearned-premium  reserve 
law,  having  enacted  in  1849  a  general  insurance  in- 
corporation law.  There  was  in  short  a  general  absence 
of  "  restrictive  legislation  "  before  the  Civil  War.  Tax- 
ation laws  were  not  burdensome  if  at  all  present.  Rates 
were  not  regulated. 

Indeed  the  subject  of  strict  regulation  of  fire  insurance 
might  well  be  taken  to  mark  a  fourth  period  in  its  de- 
velopment. This  period  may  be  said  to  date  from  about 
1885  when  valued  policy  laws,  anti-coinsurance  laws, 
and  stricter  laws  in  reference  to  the  contract,  taxation, 
rates,  and  competition  began  to  appear. 

The  excessive  competition  among  companies,  the  oft- 
recurring  rate  wars,  the  marked  fluctuations  in  rates,  the 
growth  of  trusts,  and  other  accompanying  phenomena 
of  the  rapidly  growing  industrial  life  which  occurred 
between  1870  and  1890  go  far  to  explain  the  enactment 


26 


PRINCIPLES  OF  INSURANCE 


of  these  regulating  laws  for  fire  insurance.  The  evolu- 
tion of  fire  insurance  in  the  United  States  is  similar  to 
that  of  other  important  businesses.  From  a  small 
beginning,  and  with  little  knowledge  or  experience  on 
the  part  of  those  who  transacted  the  business,  fire  in- 
surance has  kept  apace  in  its  development  with  the 
rapidly  increasing  demands  of  the  increasing  property 
values. 

General  Statistics  of  Fire  Insurance.  —  The  follow- 
ing statistics  for  1914  indicate  the  importance  of  the 
fire  insurance  business  in  the  United  States : 


NUMBER  OF 
COMPANIES 

CAPITAL 

ASSETS 

LOSSES 

EXPENSES 

301  (Stock) 
295  (Mutual) 

105,669,891 

712,774,358 
102,972,327 

207,027,774 
17,611,809 

134,507,591 
8,830,978 

There  were  eighty  foreign  companies  doing  business 
in  the  United  States  in  1914.  The  stock  fire  insurance 
companies  reporting  to  New  York  in  1914  had  out- 
standing risks  amounting  to  $56,012,859,329,  and  the 
gross  taxes  paid  by  these  companies  were  $11,352,256. 

REFERENCES 

The  Insurance  Cyclopedia,  Vols.  IV,  V.     Cornelius  H.  Walford. 

Yale  Readings  in  Insurance  (Fire),  Chaps.  I,  II. 

The  Insurance  Year  Book,  1914  (Fire).    The  Spectator  Company. 

New  York  Insurance  Reports. 

Connecticut  Insurance  Reports. 

Massachusetts  Insurance  Reports. 

Insurance  Guide  and  Handbook.    Fifth  edition. 

The  Business  of  Insurance.     Vol.  i. 


CHAPTER  II 

THE   ECONOMICS   OF   FIRE   INSURANCE 

Fire  Insurance  Defined.  —  Fire  Insurance  like  Life 
Insurance  and  all  other  forms  of  true  insurance  is  a 
method  of  combining,  assuming,  and  transferring  risks 
of  economic  loss  to  which  individuals  are  exposed.^ — 
The  insurance  or  assurance  to  the  individual  consists 
in  the  fact  that  his  loss  is  borne  by  the  group,  that  is, 
it  is  assumed  by  the  group.  It  is  transferred  from  the 
person  to  the  association.  He  is  exposed  to  the  loss 
whether  insured  or  uninsured,  but  because  his  risk  is 
combined  with  those  of  many  other  individuals,  its  sig- 
nificance for  him  is  reduced.  The  group  carries  the  / 
risk  for  less  than  he  could  do,  and  therefore  the  cost 
to  him  of  protecting  himself  is  less  as  a  member  of  this 
group  than  it  would  be  if  he  were  not  associated  with 
others,  exposed  to  like  losses.  So-called  "  self-insur- 
ance," where  an  individual  or  a  firm  having  scattered 
properties  is  content  to  let  them  go  uninsured,  is  not  a 
securing  of  an  indemnity  for  the  individual  or  the  firm, 
but  merely  means  that  the  business  is  large  enough  and 
scattered  enough  so  that  the  law  of  averages  may  be 
expected  to  apply  in  such  a  way  that  the  average  normal 
loss  will  be  less  than  the  premiums  which  would  have  to 
be  paid  to  insure  the  properties.  The  meaning  of  all 
this  is  that  an  individual  cannot  "  carry  his  risk  "  in 

27 


28  PRINCIPLES  OF  INSURANCE 

any  way  except  by  agreeing  to  accept  the  loss  if  it  comes. 
It  may  cost  him  100  per  cent  to  carry  the  risk,  or  it  may 
cost  him  nothing.  The  uncertainty  which  characterizes 
the  single  risk  is  exchanged  for  the  relative  certainty  of 
the  combined  risks,  and  this  must  be  considered  the 
prime  function  of  insurance.  The  law  of  averages 
becomes  applicable  to  the  collective  risks.  Under  the 
modern  economic  system  the  application  of  this  law  of 
averages  to  insurance  becomes  a  matter  of  accumulating 
capital  to  meet  the  demands  resulting  from  these  un- 
certain losses  to  the  individual.  The  one  who  is  in- 
sured buys  for  a  payment  called  a  premium  this  cer- 
tainty of  payment  for  his  uncertain  loss. 

The  Function  of  the  Company.  —  In  the  modern  or- 
ganization of  fire  insurance  the  company,  whether  stock 
or  mutual,  becomes  the  collector,  distributor,  and  risk 
taker.  It  collects  these  funds,  pays  the  losses,  and  as  a 
specialized  organization  does  for  society  efficiently  this 
service.  From  one  point  of  view  all  insurance  is  mutual 
in  the  sense  that  each  contributes  to  the  fund  according 
to  the  character  and  amount  of  his  risk  and  likewise 
shares  in  the  payments  for  losses  proportionally  to  his 
payments.  All  losses  are  in  the  final  analysis  paid  by 
society.  The  losses  by  fire  thus  represent  a  real 
loss  to  society.  The  individual  may,  because  of  the 
existence  of  insurance,  suffer  no  direct  and  final  loss, 
but  neither  does  the  company  as  such.  It  could  not 
pay  losses  out  of  its  own  capital.  It  must  be  paid,  not 
only  a  sum  sufficient  to  meet  all  losses,  but  also  an  ad- 
ditional sum  to  cover  the  expenses  of  transacting  the 
business  and  a  payment  for  the  services  which  it  ren- 


THE  ECONOMICS  OF  FIRE  INSURANCE      29 

ders.  This  makes  the  cost  to  society  less  than  what  it 
would  be  without  the  institution  of  insurance,  for  the 
costs  to  the  individual  uninsured  and  hence  to  society 
would  be  greater  if  there  was  no  insurance  organization. 
Not  only  do  insurance  organizations  reduce  the  hazards 
of  fire,  but  a  large  part  of  the  uncertainty  which  would 
exist  without  insurance  is  reduced  by  a  system  of  insur- 
ance. That  which  remains  is  borne  by  the  company, 
either  as  shareholders  or  as  members  of  a  mutual  organ- 
ization, w 

The  Risk  in  Stock  and  Mutual  Companies. — Yet 
there  is  a  difference  in  mutual  and  stock  organizations 
in  the  business  of  fire  insurance.  In  the  case  of  stock 
companies  the  shareholders  have  risked  their  capital 
since  certain  payments  are  guaranteed  to  the  insured, 
regardless  of  the  premium  or  payment  which  they  have 
made  to  the  company.  It  is  assumed  that  the  pay- 
ments of  policyholders  will  normally  meet  the  payments 
for  losses,  but  in  a  mutual  company  there  is  no  distri- 
bution of  losses  previous  to  the  time  of  assuming  the  , 
risk.  There  is  no  actual  transfer  of  the  risk.  It  is  not 
borne  by  a  group  of  shareholders  for  a  price  called  a 
"  premium."  As  Adam  Smith  long  since  stated,  "  in  order 
to  make  insurance  a  trade  at  all,  the  common  premium 
must  be  sufficient  to  compensate  the  common  loss,  pay 
expenses  of  management,  and  afford  such  a  profit  as 
capital  might  have  drawn  from  an  equal  capital  em- 
ployed in  any  common  trade."  Otherwise  expressed 
the  premium  must  include :  (a)  the  net  cost  of  the  in- 
demnity, (ft)  managerial  expense,  (c)  agency  com- 
missions, (d)  shareholders'  profit. 


30  PRINCIPLES  OF  INSURANCE 

The  Element  of  Interest.  —  It  must  be  understood 
that  so  far  as  pure  interest  on  capital  is  concerned  there 
is  no  essential  difference  between  the  stock  and  the 
mutual  principle.  The  contributors  to  the  mutual 
society  expect  to  receive  through  their  organization  a 
return  at  least  equal  to  that  which  they  could  secure 
from  other  sources.  The  shareholders  obtain  as  in- 
dividuals a  return,  made  up  in  part  of  risk  interest  and 
in  part  of  entrepreneur's  profit.  The  risk  interest  as 
well  as  the  normal  interest  would  be,  under  perfect  con- 
ditions of  competition,  no  different  from  that  obtained 
by  members  of  the  mutual  organization.  In  the  one 
case  the  shareholders  have  set  aside  their  capital  and 
have  transferred  to  them  definite  individual  risks.  In 
the  mutual  company  the  capital  is  not  advanced  nor  is 
the  certainty  of  the  loss  known ;  that  is,  there  has  been 
no  actual  transfer  by  contract  of  the  risk. 

The  shareholder  may  also  receive  profit  from  the 
fact  of  the  superiority  of  his  company  over  other  stock 
and  mutual  organizations,  especially  since  competition 
does  not  work  perfectly.  If  each  organization  were 
equally  skillful  in  selecting  and  measuring  risks,  in 
operating  the  company,  in  investing  the  funds,  and  in 
all  other  phases  of  the  business,  then  only  normal  in- 
terest could  be  secured  by  the  shareholder. 

The  Nature  of  the  Risk.  —  The  company  as  such 
regulates  the  contribution  of  its  members  to  the  fund 
out  of  which  the  ordinary  losses  are  paid.  That  is, 
the  company  assesses  upon  the  insured  the  cost  of  the 
hazard  or  the  measure  of  the  risk,  in  combination  with 
many  other  risks.  What  would  therefore  be  an  ab- 


THE  ECONOMICS  OF   FIRE  INSURANCE      31 

normal  hazard  or  charge  to  the  individual  becomes  nor- 
mal through  this  method  of  combination.  The  indi- 
vidual is  indemnified  for  his  loss  by  the  payment  of  a 
sum  much  smaller  than  would  be  sufficient  to  enable 
him  individually  to  provide  for  the  risk.  Self-insurance 
is  impossible  for  most  property  owners,  since  a  very 
large  fund  would  need  to  be  set  aside  to  produce  a  re- 
turn equal  to  the  small  sum  which  the  insured  pays  for 
an  insurance  premium.  The  company  as  an  organization 
reduces  chance  by  this  combination  of  many  risks.  It 
avoids  the  risk  of  any  continual  abnormal  loss  by  dis- 
tributing its  risks.  It  limits  the  amount  of  its  risks, 
for  example,  in  the  congested  districts  of  cities.  It 
penalizes  bad  risks  in  the  form  of  a  higher  charge  for 
the  protection. 

The  Risk  in  Life  and  Fire  Insurance.  —  The  risk  to 
the  company  is  a  result  of  the  character  and  amount 
of  property  insured.  If  the  measurement  of  the  hazard 
has  been  correct,  the  actual  risk  does  not  increase  at  an 
equal  rate  with  the  amount  of  the  insurance,  since  not 
only  has  the  company's  accumulations  proportionally 
increased,  but  the  chance  of  deviation  from  the  nor- 
mally expected  hazard  is  also  smaller  as  the  size  of  the 
business  increases.  Yet  as  compared  with  life  insur- 
ance, the  risk  in  fire  insurance  is  more  nearly  in  har-*' 
mony  with  the  volume  of  the  business.  This  is  due 
in  part  because  of  the  liability  of  large  losses,  due  to  '/ 
conflagrations,  and  in  part  because  of  the  great  variation 
in  the  character  of  the  individual  risks. 

It  has  been  shown  that  the  chief  elements  of  the  risk 
in  life  insurance  are  found  in  the  mortality  rate  and 


32  PRINCIPLES  OF  INSURANCE 

the  investment  rate.  The  burning  rate  corresponds, 
so  far  as  there  is  any  correspondence,  to  the  mortality 
rate  in  life  insurance.  There  is,  however,  greater  homo- 
geneity among  insured  lives  than  among  insured  prop-' 
erties.  In  life  insurance  a  selection  of  normal  lives 
has  been  made,  and  while  these  lives  lend  themselves 
to  certain  classifications  on  the  basis  of  sex  and  age, 
and  while  experience  of  such  insured  groups  shows 
certain  marked  variations  from  the  assumed  rate  of 
mortality,  yet  there  is  this  original  selection  of  normal 
lives  which  insures  a  large  degree  of  homogeneity  in 
the  group.  Because  the  original  basis  had  a  large  de- 
gree of  uniformity  in  it,  a  safe  degree  of  uniformity  is 
assured  in  the  result  or  experience  on  such  lives.  The 
risk  is  not,  therefore,  from  the  standpoint  of  the  insurer, 
great,  so  far  as  the  mortality  rate  is  concerned. 

In  fire  insurance  there  are  many  kinds  of  property, 
differing  not  only  as  to  construction,  but  also  to  the 
use  to  which  it  is  put  and  the  care  with  which  it  is  used, 
as  well  as  to  the  extent  of  danger  from  adjoining  prop- 
erties. Heterogeneity  rather  than  homogeneity  is  the 
characteristic.  It  is  true  that  a  certain  selection  is 
made,  as  in  life  insurance,  but  it  is  not  a  selection  which 
secures  an  equal  degree  of  uniformity.  A  frame  drug 
store  in  an  outlying  district  may  be  quite  as  good  a 
risk  as  a  brick  drug  store  in  a  congested  district.  There 
is  not,  therefore,  possible  a  selection  of  buildings  of  the 
same  class  and  description  similar  to  the  selection  pos- 
sible in  life  insurance  by  medical  examination. 

A  particular  class  of  buildings,  as,  for  example,  dwell- 
ing houses,  may  even  show  a  favorable  return  for  one 


THE  ECONOMICS  OF  FIRE  INSURANCE      33 

year  in  one  region  and  an  unfavorable  result  in  another 
region ;  or  the  class  as  a  whole  may  show  good  results 
for  one  year  and  poor  results  for  the  next  year,  due  to 
a  heavy  loss  in  one  place.  There  are  also  forces  in 
operation  which  tend  to  produce  decided  changes  in 
comparatively  brief  periods  of  time.  The  use  of  new 
building  materials,  the  enactment  of  more  stringent 
building  codes,  and  the  improvement  in  fire  protection, 
are  but  examples  of  the  causes  which  very  materially 
and  quickly  affect  loss  ratios  on  different  buildings  and 
in  different  regions. 

However  great  may  have  been  the  advance  in  medical 
science  and  the  discoveries  in  hygiene  and  sanitation, 
the  effect  on  insured  lives  will  show  itself  slowly.  It  is 
sometimes  stated  that  fire  insurance  differs  from  life 
insurance  in  that  the  former  has  a  rate  for  each  risk, 
while  the  latter  makes  rates  for  classes  of  individual 
risks  on  the  basis  of  their  age  and  general  physical 
vigor.  This  is  true  to  a  certain  extent,  as  will  be  shown 
later  in  detail,  but  the  comparison  can  easily  be  pushed 
too  far.  Schedule  rating  with  its  specific  charges  for 
specific  features  of  the  risk  has  done  much  to  individu- 
alize fire  insurance  rates,  but  there  is  a  very  definite 
and  desirable  limit  to  the  individualizing  of  fire  rates. 

While  there  may  be  good  reasons  for  difference  of 
opinion  in  reference  to  the  exact  economic  classification 
of  the  payment  which  is  made  to  the  insurer,  yet  there 
can  be  no  difference  of  opinion  as  to  the  real  economic 
service  which  insurance  renders.  Like  most  economic 
incomes,  the  income  from  insurance  is  often  composed 
of  several  elements.  It  may  include  ordinary  interest, 


34  PRINCIPLES  OF  INSURANCE 

risk  interest,  pure  profit,  wages,  and  rent.  However, 
it  is  more  important  to  recognize  the  exact  relation  of 
fire  insurance  to  production,  credit,  and  distribution. 

Fire  Insurance  and  Production.  —  The  relation  of 
fire  insurance  to  production  is  of  two  kinds.  In  the 
first  place,  the  fact  that  a  capital  good  is  insured  against 
its  loss  by  fire  does  not  directly  increase  the  produc- 
tivity of  that  good.  If  it  is  destroyed  before  it  has 
earned  its  normal  interest  on  the  capital  invested  and 
before  it  has  earned  a  replacement  fund,  the  owner 
obtains  a  sum  sufficient  to  purchase  another  capital 
good,  but  this  payment  comes  out  of  the  earnings  of 
the  productive  factors  which  have  been  accumulated. 
The  insured  has  also  been  paying  out  of  his  past  pro- 
duction a  certain  sum  in  the  form  of  an  insurance  pre- 
mium. The  receipt  of  the  sum  for  a  destroyed  capital 
good  is  not  therefore  a  clear  gain  either  for  him  or  for 
society.  Capital  has  been  set  aside  to  insure  capital.- 
How  much  has  been  contributed  to  his  efficiency  and 
to  society's  efficiency  in  production  by  the  fact  that  the 
goods  are  insured  and  hence  a  feeling  of  ease  in  refer- 
ence to  future  results  is  a  question  which  cannot  be 
answered  or  its  productive  effects  measured  in  any 
known  way.  All  may  agree  that  the  modern  system 
of  producing  goods  could  not  be  carried  on  without 
the  insurance  of  the  tools  of  production,  but  no  one  can 
say  how  productive  this  service  of  insurance  is.  It  may 
be  argued  that  the  measure  of  its  productivity  is  to  be 
found  in  that  amount  of  the  social  income  which  is  set 
aside  to  pay  for  the  insurance.  It  is  true  that  a  part 
of  the  product  of  the  capital  that  is  insured  is  set  aside 


THE  ECONOMICS  OF  FIRE   INSURANCE      35 

to  pay  for  insurance.  But  what  is  paid  at  any  one  time 
to  the  insured  has  come  out  of  past  productivity  and 
what  is  paid  in  by  the  insured  is  set  aside  for  payments 
to  be  made  in  the  distant  future. 

The  effect  of  insurance  on  the  supply  of  capital  for 
investment  in  industry  is  important.  Insurance  by 
its  character  reduces  risk  interest  and  therefore  de- 
creases the  supply  price  of  a  given  amount  of  capital; 
that  is,  the  amount  of  capital  which  will  be  supplied  at 
a  given  price  is  increased.  The  net  result  of  all  this  is 
that  saving  and  thrift  are  stimulated. 

In  the  second  place  the  sum  which  is  set  aside  at  any 
one  time  by  the  insured  from  the  proceeds  of  produc- 
tion plays  a  very  important  part  in  carrying  on  the 
productive  process.  That  is,  the  accumulations  of 
insurance  organizations  express  themselves  as  loan- 
able funds  which  finally  take  the  form  of  capital  goods 
that  directly  affect  production.  A  capital  good  in  the 
form  of  a  machine  may  thus  be  in  final  analysis  insured 
by  some  other  machine  in  another  factory.  The  in- 
sured capital  is  insured  by  capital  in  the  form  of  pro- 
ducer's goods.  The  collection  by  insurance  companies 
of  numerous  small  premiums  from  a  great  many  sources 
thus  creates  a  very  large  fund,  available  for  productive 
investment  in  addition  to  whatever  security  and  result- 
ing efficiency  come  to  the  individual  producer  from  the 
fact  that  his  property  is  insured. 

Insurance  and  Credit.  —  The  relation  of  insurance  to 
credit  is  more  easily  observed.  The  fact  that  the  stock 
fire  insurance  companies  alone  had  insurance  in  1914 
covering  over  fifty-six  billion  dollars'  worth  of  property 


36  PRINCIPLES  OF  INSURANCE 

in  the  United  States  is  indicative  of  the  role  it  plays  in 
the  modern  system  of  production  in  which  credit  is  so 
important.  No  important  loan  would  be  placed  on 
property  unless  that  property  was  insured.  No  large 
amount  of  goods  would  be  shipped  unless  insurance 
was  taken  to  cover  them  while  in  transit  except  when 
certain  recovery  could  easily  be  made  from  the  car- 
rier. This  last  amounts  to  insurance.  No  important 
building  would  be  constructed  without  insurance  to 
cover  it  during  the  course  of  construction.  It  is  be- 
cause of  fire  insurance  that  producers  and  property 
owners  are  guaranteed  that  they  will  be  able  to  con- 
tinue to  use  their  productive  goods  during  their  normal 
length  of  life,  and  when  a  fire  destroys  them,  the  amount 
paid  to  the  insured  is  in  a  sense  the  present  discounted 
value  of  their  future  productivity. 

Insurance  and  Distribution.  —  The  relation  of  insur- 
ance to  distribution,  used  in  the  economic  sense,  is 
found  in  the  relation  it  has  to  the  shares  of  the  economic 
income  which  go  to  the  various  factors  in  production. 
The  large  number  of  laborers  who  are  engaged  in  the 
business  as  agents,  officers,  office  employees,  rate  ex- 
perts, and  adjusters  of  losses  are  paid  wages  for  their 
services.  A  small  sum  is  paid  as  rent  to  those  who  own 
the  land  used  in  conducting  the  business.  A  large  sum 
is  paid  as  interest  for  the  large  amount  of  capital  in- 
vested in  the  business.  A  certain  sum,  probably  not 
large  in  the  aggregate,  is  paid  as  pure  profit.  Whether 
a  saving  might  be  made  to  society  by  a  system  of  state 
or  pure  mutual  insurance  may  be  a  debatable  question, 
but  so  far  as  it  is  a  question  of  the  excessive  cost  of 


THE  ECONOMICS  OF  FIRE  INSURANCE      37 

insurance,  there  are  open  to  society  many  ways  of  re- 
ducing this  economic  cost  under  the  present  system. 
Among  other  aspects  of  the  unnecessary  cost  of  fire  in- 
surance the  following  may  at  this  point  be  considered : 

(a)  The  excessive  losses  by  fire. 

(&)  The  excessive  competition  in  the  business. 

(c)  The  expenses  of  the  business. 

The  Fire  Loss.  —  The  loss  by  fire  in  the  United  States 
and  Canada  has  during  the  past  thirty-eight  years  been 
$5,866,981,025,  or  an  annual  average  of  $154,294,237. 
This  does  not  include  the  many  unreported  losses 
which  in  the  aggregate  have  amounted  to  millions  of 
dollars.  When  it  is  recognized  that  this  loss  represents 
a  real  and  permanent  destruction  of  capital  which  is 
only  replaced  by  setting  aside  a  part  of  the  product  of 
economic  enterprise,  the  significance  of  it  is  apparent. 
To  the  extent  that  it  can  be  reduced  there  is  a  clear 
gain,  since  the  insurance  organization  merely  represents 
in  this  connection  an  assessing  agency  to  levy  upon 
production  this  added  cost.  No  other  modern  industrial 
nation  incurs  such  a  fire  loss  as  does  the  United  States, 
based  either  upon  population,  buildings,  or  value  of 
buildings.  The  explanation  of  this  large  loss  by  fire 
is  to  be  found  in  the  following  facts,  which  will  in  later 
chapters  be  discussed  in  greater  detail. 

(a)  The  character  of  construction  in  the  United  States. 
The  abundance  and  cheapness  of  lumber  make  wood 
the  most  commonly  used  building  material. 

(6)  The  absence  of  strict  laws  governing  the  con- 
struction of  buildings  and  their  use.  It  has  been  and 
yet  is  difficult  in  most  states  and  cities  in  the  United 


38  PRINCIPLES  OF  INSURANCE 

States  to  secure  the  enactment  of  laws  and  ordinances 
which  require  the  proper  construction  and  maintenance 
of  buildings  with  a  view  of  reducing  the  dangers  of  fires. 
The  American  idea  of  personal  liberty  is  interpreted  as 
a  license  to  subject  one's  neighbor  and  the  community 
to  a  risk  of  fire.  Buildings  are  constructed  with  shingle 
roofs  and  inadequate  walls ;  machinery  is  used  and  pro- 
cesses of  manufacture  or  trade  are  carried  on  which  have 
a  high  fire  hazard ;  inflammable  material  is  carelessly 
kept  in  the  building ;  refuse  is  permitted  to  accumulate. 
All  these  and  many  other  factors,  contributing  to  the 
fire  hazard,  are  yet  to  be  found  in  almost  any  Ameri- 
can city.  Frequent  fires  are  the  rule  and  conflagrations 
are  of  periodic  occurrence.  Enactment  of  better  build- 
ing codes  and  the  enforcement  of  careful  use  of  buildings 
are  opposed.  If  the  charge  for  the  insurance  is  ad- 
vanced, the  insurance  companies  are  accused  of  monop- 
olisitic  activities.  If  a  property  owner  with  a  better 
building  is  given  a  lower  rate  for  his  insurance,  the 
insurance  company  is  accused  of  discrimination.  Im- 
provement has  come  but  very  slowly.  The  American 
city  has  grown  so  rapidly  and  its  property  values  change 
so  rapidly  from  section  to  section  of  the  city,  that  it 
has  been  difficult  to  build  permanently.  It  has  often 
been  true  that  "  to  build  and  let  burn  "  has  been  cheaper 
than  to  build  permanently. 

(c)  The  inadequate  fire  protection  of  American  cities 
in  the  form  of  good  water  protection  and  fire  depart- 
ments. There  may  be  no  water  protection  or  it  may  be 
of  insufficient  quantity  and  pressure.  The  fire  depart- 
ment may  lack  sufficient  equipment  or  be  subject  to 


THE  ECONOMICS  OF  FIRE  INSURANCE      39 

political  influence  in  the  appointment  of  its  employees. 
In  general  the  fire  departments  of  American  cities  rank 
very  high  in  personnel  and  equipment.  Indeed,  prob- 
ably no  other  factor  is  more  responsible  for  keeping  the 
fire  loss  as  low  as  it  is.  The  enormous  sums  expended 
for  these  fire  departments,  high  pressure  water  mains, 
and  other  fire  protection  agencies  must  be  added  to  the 
fire  premium  in  any  calculation  of  the  cost  of  fires. 

(d)  The  enactment  by  many  states  of  valued  policy, 
anti-coinsurance,  and  anti-trust  laws  which  tend  to  pre- 
vent a  more  rapid  reduction  of  the  fire  loss.  Each  of 
these  laws  will  be  discussed  later. 

Insurance  Companies  and  Fire  Losses.  —  It  is  a 
popular  error  on  the  part  of  many  that  the  fire  insurance 
organizations  are  not  interested  in  the  reduction  of  losses 
by  fires ;  that  is,  that  they  are  beneficiaries  from  fires ; 
that  the  more  numerous  the  fires  and  the  greater  the 
losses,  the  greater  the  amount  of  their  business.  The 
complete  answer  to  this  question  cannot  be  given  until 
many  phases  of  fire  insurance  are  discussed,  but  one  of 
the  chief  errors  in  the  assumption  may  here  be  noted. 
In  the  first  place,  the  facts  are  against  the  assumption, 
for  it  is  well  known  that  fire  insurance  organizations 
spend  annually  large  sums  directly  and  indirectly  in  an 
effort  to  reduce  the  loss  by  fire.  In  the  second  place 
it  is  not  true  on  pure  grounds  of  theory  that  the  fire 
insurance  companies  are  indifferent  as  to  the  fire  losses. 
Fire  insurance,  like  life  and  most  other  forms  of  insur- 
ance, is  predicated  on  the  law  of  averages,  or  the  regu- 
larity of  predictable  phenomena.  If  there  was  no  uni- 
formity in  construction  or  in  the  rules  for  the  use  of 


40  PRINCIPLES  OF  INSURANCE 

buildings  and  if  each  were  permitted  to  build  wherever  he 
pleased  and  use  his  building  in  any  manner  he  pleased, 
the  insuring  of  buildings  in  a  modern  industrial  city 
would  be  impossible.  Standardization  and  uniformity 
are  necessary  as  a  basis  for  calculating  with  any  degree 
of  certainty  the  costs  of  fire  insurance  protection.  Such 
costs  are,  as  will  later  be  shown,  far  from  absolutely 
accurate  as  to  individual  risks,  for  with  all  the  possible 
uniformity  and  standardization  which  can  be  obtained, 
each  risk  has  many  elements  which  defy  analysis  for 
the  purpose  of  calculating  its  contribution  to  the  fire 
hazard. 

In  the  third  place  the  public  does  get  the  benefit  of 
reducing  the  fire  hazard,  both  because  the  laws  of  most 
states  secure  it  for  them,  and  also  because  the  competi- 
tion for  business  among  the  insurance  organizations 
guarantees  that  for  which  the  legal  regulation  of  com- 
panies provides. 

Is  Insurance  a  Monopoly?  —  This  leads  to  a  brief 
consideration  of  the  character  of  insurance  as  a  busi- 
ness. Is  it  by  its  very  nature  a  competitive  or  monop- 
olistic business?  There  are  in  the  first  place  many 
different  organizations,  including  stock  and  mutual  com- 
panies, competing  with  each  other  for  the  business  of 
insuring  property.  Some  are  large  and  some  are  small. 
They  have  been  organized  and  now  operate  in  many 
different  states.  Each  seeks  to  secure  the  most  desir- 
able business,  that  is,  the  business  which  has  produced 
the  greatest  profit.  If  therefore  any  community  or 
individual  takes  such  measures  as  will  reduce  the  risk 
of  loss  by  fire  to  the  property,  no  one  company  will  be 


THE  ECONOMICS  OF  FIRE  INSURANCE     41 

able  to  secure  and  hold  the  business  of  that  community 
or  individual  at  a  large  margin  of  profit.  There  is  no 
absence  of  competition  for  business,  and  the  excessive 
competition  has  in  fact  at  times  resulted  in  great  injury 
to  individuals  and  to  the  business  as  a  whole.  This 
has  occurred  partly  because  there  has  not  been  equal 
bargaining  power  among  large  and  small  property 
holders  and  partly  because  the  excessive  rate  cutting 
has  sometimes  led  the  lawmakers  to  enact  legislation 
inimical  to  the  best  interests  of  the  public.  As  the 
business  is  at  present  conducted,  its  very  character 
induces  excessive  competition  and  this  natural  tendency 
is  aided  by  mistaken  legislation  which  has  for  its  pur- 
pose the  placing  of  a  premium  on  competition  by  the 
companies.  The  laws  of  many  states  prevent  the  com- 
panies from  cooperating  in  rate-making  and  in  inspec- 
tion work,  from  agreeing  as  to  commissions,  and  in 
other  ways  cooperating,  which,  if  done  under  the  super- 
vision of  the  state  might  very  materially  reduce  the 
expenses  of  the  business.  Insurance  is  in  many  re- 
spects a  business  subject  to  the  law  of  decreasing  costs, 
but  in  an  effort  to  secure  the  advantages  or  economics 
of  this  principle  the  companies  are  induced  by  the 
condition  of  the  business  and  the  character  of  the  laws 
to  make  outlays  which  go  far  to  counteract  the  possible 
advantages  of  this  principle  of  decreasing  cost  with 
increasing  business.  A  company  must  take  poor  and  bad 
risks  along  with  good  risks.  The  agent  who  may  repre- 
sent several  companies  will  not  give  one  company  all 
the  good  risks  unless  perchance  he  is  for  a  time  persuaded 
to  do  so  because  he  is  given  a  high  commission,  and  if 


42  PRINCIPLES  OF  INSURANCE 

this  is  done,  this  counteracts  the  advantage  of  getting 
the  good  risks.  In  practice,  however,  the  agent  can- 
not continually  discriminate  in  this  manner.  The 
excessive  competition,  together  with  the  character  of 
the  business  and  its  present  organization,  explains  the 
apparent  large  expense  for  its  conduct.  This  expense 
element  is  from  35  to  55  per  cent  of  the  total  outlay. 
This  includes  taxes  and  all  other  items  of  expense.  The 
selling  price  of  ordinary  commodities  includes  the  cost 
of  raw  material,  the  cost  of  preparation  through  many 
stages,  and  many  middlemen's  profit  and  wages.  In- 
surance is  itself  a  finished  product,  and  the  consumer 
pays  in  one  price  what  corresponds  to  the  original  cost 
and  all  the  various  succeeding  costs  and  expenses  of 
other  products.  The  expense  seems  larger  partly  be- 
cause it  is  condensed  at  one  point. 

Competition  and  the  Fire  Cost.  —  Notwithstanding 
this  fact  of  competition  among  the  business  units 
selling  fire  insurance  protection,  the  chief  factors  deter- 
mining the  cost  of  the  indemnity  are  beyond  the  influ- 
ence of  this  competition.  No  amount  of  actual  compe- 
tition on  the  part  of  the  companies  for  the  business  can 
materially  affect  the  burning  rate.  This  is  the  chief 
factor  in  the  cost  of  fire  insurance.  The  competing 
units  find  the  cost  very  largely  determined  by  factors 
beyond  their  control.  For  this  reason  many  of  the 
principles  applying  to  the  ordinary  competing  business 
do  not  apply  to  fire  insurance.  There  are  more  elements 
of  a  static  and  permanent  character  over  which  the 
producer  —  the  insurer  —  has  less  control  than  the  pro- 
ducer in  a  normal  competitive  business. 


THE  ECONOMICS   OF  FIRE  INSURANCE      43 

It  is  true  that  a  considerable  field  exists  for  the  exer- 
cise of  superior  ability,  such,  for  example,  as  the  more 
careful  selection  of  good  risks,  superior  labor  force  — 
agents  and  other  employees  —  the  proper  distribution 
of  risks,  and  the  careful  investments  of  the  accumulated 
funds,  so  as  to  yield  the  highest  possible  return.  It  is 
in  these  and  related  aspects  of  the  business  that  the 
principle  of  competition  in  fire  insurance  finds  its  true 
field  and  justification.  Yet  the  total  amount  required 
for  the  payment  of  fire  losses  and  expenses  is  such  a 
large  part  of  the  total  amount  collected,  that  the  public 
is  in  no  danger  of  being  charged  a  monopoly  price  for  the 
protection.  When  the  subject  of  rates  and  rating  is 
considered  it  will  be  shown  that  the  forces  of  competi- 
tion cannot  be  trusted  to  determine  a  large  part  of  the 
charge  for  the  pure  protection.  This  is  determined  by 
forces  outside  of  the  fire  insurance  organization  and 
should  not  respond  to  "  the  higgling  of  the  market." 
The  business  is  not  therefore  a  purely  competitive  one 
in  the  common  acceptance  of  that  term.  Its  price 
does  not  change  from  season  to  season  in  response  to 
the  fluctuating  conditions  of  demand  and  supply  as  in 
the  ordinary  competitive  business.  Nor  can  the  busi- 
ness be  said  to  illustrate  completely  the  economic  prin- 
ciples either  of  decreasing  or  increasing  cost.  There 
are  many  organizations  with  a  small  volume  of  business 
which  have  as  low  a  unit  cost  of  production  as  large 
organizations.  Small  mutual  companies  may  have 
either  large  or  small  expenses.  Likewise  the  unit  of 
expense  for  different  stock  companies  varies  greatly. 
This  is  largely  true  because  the  personal  factor  and 


44  PRINCIPLES  OF  INSURANCE 

chance  play  such  important  parts  in  the  business  of 
fire  insurance.  Carefully  selected  risks,  efficiency  in 
the  organization,  and  well-invested  funds  have  a  power- 
ful effect  on  the  expense  rates. 

REFERENCES 

Yale  Readings,  Chapter  III. 

Proceedings  National  Board  of  Fire  Indemnities,  1915. 

W.  F.  Gephart,  Insurance  and  the  State. 


CHAPTER  III 

THE   BUSINESS   ORGANIZATION   OF   FIRE   INSURANCE 

How  Fire  Insurance  is  Conducted.  —  Fire  insurance 
may  be  conducted  either  as  a  public  or  a  private  busi- 
ness. The  vast  majority  of  it  is  conducted  as  a  private 
business,  and  in  the  United  States  there  are  no  impor- 
tant examples  of  public  insurance.  Nor  do  the  national, 
state,  and  local  governments  usually  insure  public  prop- 
erty ;  they  rely  on  the  taxation  power  for  the  money  to 
replace  public  property  destroyed  by  fire.  In  some 
cases  local  governing  bodies  such  as  township  and 
school  officials  insure  the  public  property  under  their 
control  in  the  same  manner  as  does  the  owner  of  private 
property. 

Classes  of  Private  Organizations.  —  The  private 
insurance  organizations  are  of  three  general  classes: 
stock  companies,  mutual  companies,  and  various  asso- 
ciations such  as  individual  underwriters,  Lloyds,  and 
interinsurance  organizations.  The  stock  companies  may 
be  either  domestic  companies  or  branches  of  foreign 
companies  which  operate  in  the  United  States  and  which 
on  account  of  the  statutory  requirements  of  most  states 
become  practically  domestic  companies.  These  state 
laws  require  of  the  branch  of  the  foreign  company 
the  maintenance  of  a  legal  representative  in  this  coun- 

45 


46  PRINCIPLES  OF  INSURANCE 

try,  the  periodic  valuation  of  their  assets,  and  the  main- 
tenance of  a  fund  to  guarantee  the  payment  of  the 
claims.  The  investment  of  this  fund  is  also  governed 
in  the  same  manner  as  those  of  domestic  companies, 
that  is,  only  specified  kinds  of  securities  may  be  pur- 
chased. Other  regulations  must  be  observed  with  a 
view  of  protecting  the  policyholders  in  this  country. 
The  foreign  shareholders  may  advance  additional  capi- 
tal in  the  form  of  assessments  on  their  stock  holdings 
at  the  time  of  large  losses  and  thus  protect  their  busi- 
ness in  this  country.  In  1914  there  were  in  the  United 
States  three  hundred  and  one  stock  fire  insurance  com- 
panies and  two  hundred  and  ninety-five  mutual  com- 
panies. Of  these  stock  companies,  eighty  were  foreign 
companies. 

How  a  Company  is  Organized.  —  The  method  of 
procedure  in  organizing  a  stock  fire  insurance  company 
is  usually  prescribed  by  the  special  insurance  laws  of 
each  state.  If  a  company,  organized  in  one  state,  de- 
sires to  enter  another  state  to  transact  business,  it  must 
comply  with  the  laws  of  that  state.  Insurance  is  not 
interstate  business,  and  it  is  therefore  subject  to  the  laws 
of  each  state.  In  organizing  a  company  the  first  step 
is  to  provide  the  capital  by  the  sale  of  shares  of  stock  in 
the  proposed  company.  In  New  York  State  the  mini- 
mum full  paid  cash  capital  is  $200,000.  This  capital 
must  be  maintained  without  any  impairment.  It  is 
therefore  necessary  to  have  funds  to  establish  the 
company  and  to  provide  a  surplus.  This  is  secured 
by  selling  the  stock  at  such  a  premium  as  to  provide 
this  surplus  for  initial  expense  and  as  an  operating  sur- 


BUSINESS  ORGANIZATION  47 

plus.  Frequently  the  stock  is  sold  at  a  premium  oi 
100  per  cent ;  that  is,  for  every  one  hundred  dollars'  worth 
of  stock  two  hundred  dollars  is  paid.  After  subscrip- 
tion to  the  stock  has  been  obtained,  the  next  require- 
ment is  a  public  advertisement  of  the  fact  that  such  a 
company  is  in  process  of  organization.  This  notice  is 
a  public  statement  of  the  purpose,  the  name  of  the  pro- 
posed company,  the  office  address,  and  the  names  of 
the  incorporators,  which  in  New  York  must  not  be  less 
than  thirteen.  No  name  can  be  used  which  is  the  same 
or  so  similar  to  a  company  in  the  state  as  is  likely  to  cause 
confusion.  After  two  weeks'  notice,  proof  of  these  facts 
is  made  to  the  superintendent  of  insurance  and 
the  attorney-general  of  the  state.  The  list  of  sub- 
scribers as  well  as  other  details  of  the  proposed  com- 
pany is  filed.  A  committee  of  the  subscribers  is  selected 
under  the  supervision  of  the  insurance  superintendent, 
which  calls  for  the  payment  of  the  subscriptions  to  the 
stock.  These  are  collected  and  deposited.  A  meeting 
of  all  the  subscribers  to  the  stock  is  then  called  for  the 
purpose  of  adopting  by-laws  and  accepting  the  charter 
to  do  business  which  is  issued  by  the  state  authorities. 
If  66  per  cent  of  the  subscribers  accept  the  charter  and 
by-laws,  they  become  binding  on  the  remainder,  and 
stock  certificates  are  issued  to  the  shareholders.  The 
stockholders  then  elect  the  directors  of  the  company 
and  select  a  president  and  possibly  some  other  impor- 
tant officers  of  the  company.  A  list  of  officers,  directors, 
and  other  officials,  together  with  other  information  re- 
garding the  organization  of  the  company,  is  then  sent 
to  the  insurance  superintendent. 


48  PRINCIPLES  OF  INSURANCE 

The  Charter.  —  If  all  legal  requirements  have  been 
met,  the  company  is  then  issued  a  certificate,  authoriz- 
ing it  to  transact  business.  This  certificate  to  do  busi- 
ness is  to  be  distinguished  from  the  charter.  The 
charter  in  New  York  State  is  issued  for  a  maximum  of 
thirty  years,  but  a  renewal  is  usually  a  matter  of  for- 
mality. The  charter  and  the  certificate  issued  to  a 
fire  company  usually  carry  with  them  the  right  to  issue 
tornado,  earthquake,  hail,  explosion  protection,  sprinkler 
leakage,  and  automobile  policies.  This  provision  differs 
somewhat  in  different  states.  In  some  states,  as  for 
example  New  York,  such  a  fire  insurance  company 
cannot  issue  ocean  marine  insurance  policies  unless  its 
capital  stock  is  at  least  $400,000. 

The  Board  of  Directors.  —  A  fire  insurance  company 
has  several  important  committees  of  its  board  of  direc- 
tors. Two  of  the  most  important  are  the  executive 
committee,  which  has  general  supervision  over  the 
business  policy  of  the  company,  and  the  finance  com- 
mittee, which  supervises  the  investment  of  the  funds. 
In  most  states  either  no  deposit  or  a  very  small  one  is 
required  to  be  made  with  the  state.  Some  states  re- 
quire corporation  security  bonds,  but  it  is  coming  more 
clearly  to  be  recognized  that  the  best  protection  to 
policyholders  is  in  a  careful  inspection  of  the  com- 
pany's business,  the  periodic  valuation  of  their  assets, 
and  other  kinds  of  supervision.  Most  states  limit  the 
kinds  of  securities  which  may  be  held  by  a  fire  insurance 
company  and  also  prescribe  methods  of  valuing  the 
assets  which  are  made  by  the  department  of  insurance 
from  time  to  time. 


BUSINESS  ORGANIZATION  49 

Mutual  Organizations.  —  In  point  of  numbers  the 
mutual  associations  are  more  numerous  than  stock 
companies,  but  the  value  of  property  insured  in  this  class 
of  organizations  is  less  than  that  of  the  stock  com- 
panies. There  are  three  types  of  mutual  societies ;  the 
local  mutuals,  the  general  mutuals,  and  the  factory 
mutuals.  The  laws  governing  the  formation  and  opera- 
tion of  these  societies  vary  considerably  in  different 
states.  Some  states  have  little  regulation  over  such 
organizations,  while  others  require  a  certain  amount  of 
insurance  to  be  secured  before  a  charter  is  issued ;  the 
territory  of  operation  is  sometimes  limited  as  well  as 
the  kind  of  property  which  can  be  insured. 

Local  Mutuals. — The  local  mutuals  are  usually  formed 
by  farmers  of  townships  or  counties  and  by  property 
owners  of  villages  to  protect  the  property  of  the  mem- 
bers. After  a  certain  number  of  applications  are  received, 
the  members  secure  authority  from  the  proper  state 
official  to  form  the  organization.  A  meeting  of  the  sub- 
scribers is  held  and  officers  are  selected.  These  usually 
consist  of  a  president,  a  secretary-treasurer,  and  an  ex- 
ecutive committee.  Either  no  salary  or  a  nominal  one  is 
paid  to  these  officials,  except  the  secretary-treasurer, 
who  in  connection  with  his  regular  business  looks  after  the 
details  of  the  insurance  society.  No  agents  as  such  are 
employed,  and  often  no  funds  are  collected  in  advance 
as  the  stock  company  does.  Meetings  are  held  annually 
or  semiannually.  When  losses  occur  money  to  pay  the 
loss  may  be  borrowed  from  a  bank  or  some  individual, 
and  at  the  close  of  the  year  the  losses  are  assessed  upon 
the  individual  members  on  the  basis  of  the  value  of 


5C  PRINCIPLES  OF  INSURANCE 

their  insured  property.  In  the  case  of  the  farmers' 
mutuals,  the  insured  property  usually  is  limited  to  farm- 
houses and  outbuildings.  The  members  of  the  asso- 
ciation solicit  their  neighbors'  insurance,  and  since  an 
intimate  knowledge  of  each  other's  business  and  property 
exists,  the  moral  hazard  is  not  great.  The  property 
insuredis  of  a  like  character,  and  no  important  question 
of  difference  in  risk,  based  upon  the  character  of  the 
property,  arises.  There  is  only  a  nominal  expense  of 
operation.  In  some  cases  the  applicant  for  insurance 
pays  a  small  premium  at  the  time  the  policy  is  issued 
and  gives  a  demand  note  for  an  additional  sum.  The 
individual  liability  may  be  limited  or  the  members 
may  be  liable  for  all  the  losses  of  the  company.  Each 
policyholder  is  in  a  sense  an  inspector  of  risks  and  a 
guardian  of  the  interests  of  the  association. 

When  these  mutual  organizations  limit  their  field  of 
operation  and  secure  the  potential  advantages  of  care- 
fully selected  risks  and  of  small  expense,  their  success 
is  very  great.  If  in  the  early  years  losses  are  heavy  and 
numerous,  the  association  is  not  likely  to  be  successful, 
since  frequent  or  heavy  assessments  lead  to  the  with- 
drawal of  members.  The  members  have  in  the  rates  of 
insurance  charged  by  the  stock  companies  an  easy 
method  of  measuring  the  success  of  the  association. 
If  the  association  does  not  furnish  the  protection  at 
a  lower  rate  than  that  which  can  be  obtained  from  the 
ordinary  commercial  companies,  it  makes  little  or  no 
appeal  either  to  old  or  new  subscribers.  Such  organi- 
zations have  little  expense,  no  taxes,  and  are  therefore 
often  able  to  secure  their  protection,  when  well  managed 


BUSINESS  ORGANIZATION  51 

and  when  they  have  no  unusual  losses,  at  a  lower  price 
than  that  charged  by  the  stock  companies.  Their 
small  business  is  an  advantage,  as  well  as  at  times  a 
disadvantage.  On  the  one  hand  they  save  in  the  heavy 
overhead  expenses  of  a  larger  company.  On  the  other 
hand,  if  abnormal  losses  are  incurred,  it  falls  heavily 
on  the  members  because  they  are  few  in  number. 

The  town  mutuals  as  contrasted  with  the  farmers' 
mutuals  are  in  some  states  more  strictly  regulated. 
Their  chance  of  success  is  somewhat  less  than  the  farm- 
ers' mutuals  because  the  property  insured  is  located 
in  small  cities  and  villages  which  often  have  no  or  in- 
adequate building  laws  and  fire  protection  in  the  form 
of  waterworks  and  fire  departments.  A  considerable 
fire  is  not  improbable,  with  the  consequent  result  of  a 
heavy  loss  and  cost  upon  the  members. 

The  stock  mutuals  or  mutual  associations  operating 
over  a  considerable  area  have  not  so  much  to  recom- 
mend them  as  the  local  mutuals.  First,  because  the 
same  care  cannot  be  used  in  selecting  the  risks,  and 
second,  because  the  expense  of  operation  is  likely  to  be 
considerable. 

Factory  Mutuals.  —  The  third  type  of  important 
mutuals  is  that  formed  by  the  owners  of  factories  or  of 
particular  business,  such  as  druggists,  lumber  dealers, 
flour  mill  owners,  or  factories  of  a  closely  related  char- 
acter. The  factory  mutuals  have  become  very  im- 
portant. The  basic  idea  of  the  factory  mutual  sys- 
tem of  insurance  is  that  losses  should  be  prevented 
instead  of  being  distributed.  Every  policyholder  is 
a  member  of  the  organization,  and  each  society  is  con- 


52  PRINCIPLES  OF  INSURANCE 

ducted  by  its  members  who  are  manufacturers.  They 
may  employ  one  or  more  salaried  officials  to  manage  the 
organization,  but  commissions,  salaries,  and  overhead 
expenses  of  the  ordinary  stock  insurance  company  are 
avoided.  The  system  was  founded  in  1835  in  New 
England  by  the  Manufacturers'  Mutual  Fire  Insurance 
Company,  and  at  present  there  are  twenty  such  large 
factory  mutual  organizations  in  addition  to  many 
smaller  similar  organizations.  These  companies,  es- 
pecially the  larger  ones,  cooperate  in  the  engineering 
and  inspection  work  connected  with  the  insuring  of 
their  properties.  Substantial  construction  is  encour- 
aged, as  well  as  the  best  possible  devices  and  methods 
for  preventing  and  controlling  fires.  Before  an  appli- 
cation for  membership  is  accepted  in  the  association  a 
careful  inspection  of  the  risk  is  made.  Certain  improve- 
ments may  be  required  in  the  risk  before  membership  in 
the  association  is  permitted.  A  blanket  policy,  that  is, 
one  covering  all  parts  of  the  risk  and  stock  of  goods,  is 
the  usual  one  issued  in  these  associations.  A  pre- 
mium is  ordinarily  collected  at  the  time  of  becoming  a 
member,  that  is,  when  the  policy  is  issued,  and  at  the 
expiration  of  the  contract  that  portion  of  the  premium 
not  used  for  the  payment  of  expenses  and  losses  is 
returned. 

Advantage  of  Mutuals.  —  The  rates  do  not  vary 
widely  for  the  different  factories  or  members,  although 
certain  differences  are  necessary  to  meet  the  differences 
in  types  of  factories  and  their  use.  These  mutual 
societies  have  been  on  the  whole  successful.  It  is  an 
example  of  cooperation  in  one  of  its  best  forms.  Not 


BUSINESS  ORGANIZATION  53 

only  has  better  construction  of  buildings  and  more 
careful  use  of  them  been  greatly  encouraged,  but  the 
result  has  been  insurance  at  a  small  cost.  The  Ark- 
wright  Factory  Mutual  Fire  Insurance  Company,  one 
of  the  oldest,  returned  during  the  years  1860  to  1910 
eighty-four  and  one  half  per  cent  of  the  premium  deposits 
to  its  members. 

In  the  case  of  other  mutual  societies  with  members 
other  than  factory  owners,  such  as  the  wholesale  or 
retail  druggists,  or  similar  businesses,  it  may  be  stated 
that  their  success  depends  very  largely  upon  the  char- 
acter of  the  managers.  They  have  neither  the  marked 
advantages  of  the  factory  mutuals  with  a  low  con- 
struction ajid  occupation  hazard  in  their  risks,  nor  the 
careful  and  close  supervision  of  the  local  farmer's 
mutuals.  Their  risks  are  usually  well  distributed  as 
to  territory,  but  there  is  often  a  wide  variation  in  the 
character  of  the  particular  risks  both  in  their  con- 
struction and  use.  The  hazard  of  a  particular  risk 
is  only  partly  determined  by  the  character  of  the  busi- 
ness. A  wholesale  drug  house  in  one  city  may  have 
a  risk  ten  times  as  great  as  one  in  another  city,  al- 
though the  business  conducted  may  be  practically 
identical. 

Stock  and  Mutual  Plan  Compared.  —  It  may  be 
inquired  after  this  discussion  of  the  stock  and  mutual 
plan  of  fire  insurance  whether  one  is  superior  to  another. 
It  is  impossible  to  be  dogmatic.  Each  plan  under  cer- 
tain circumstances  has  much  to  recommend  it.  Each 
has  a  proper  field  of  application.  The  local  farmers' 
and  the  factory  mutuals  have  on  the  whole  been  sue- 


54  PRINCIPLES  OF  INSURANCE 

cessful  when  properly  limited  as  to  territory  and  risk, 
and  there  is  no  reason  arising  out  of  the  theory  and 
principles  of  fire  insurance  why  they  should  not  be  an 
increasing  success.  The  member  of  a  mutual  society 
exposes  himself  to  a  large  loss  through  his  liability  to 
assessment  for  any  abnormal  loss  which  may  occur; 
yet  when  the  farmers'  mutual  insures  only  farmhouses 
and  buildings  widely  separated  such  heavy  losses  are 
not  probable.  Nor  are  such  losses  likely  to  be  abnormal 
in  the  case  of  factory  mutuals  if  there  has  been  care- 
ful inspection  of  the  risk  before  insuring  it  and  its  use 
after  insurance,  and  provided  further  that  an  unduly 
large  amount  of  insurance  is  not  written  on  a  single  risk 
or  in  one  location.  That  is,  the  single  risk  should  not 
be  a  large  percentage  of  the  total  amount  of  property 
insured  in  the  organization. 

Advantage  of  the  Stock  Plan.  —  When,  however,  all 
the  possible  advantages  are  stated  for  the  mutual  prin- 
ciple in  fire  insurance,  there  yet  remains  a  large  field  of 
operation  for  the  stock  fire  insurance  principle.  The 
advantages  of  the  stock  companies  are  very  clear.  The 
policyholder  assumes  no  liability.  He  pays  a  stated 
premium  and  receives  the  protection.  No  assessment 
is  made  upon  him,  however  great  the  losses  of  the  com- 
pany may  be.  The  shareholders  are  the  risk  takers. 
The  uncertainty  which  is  connected  with  the  potential 
loss  by  fire  to  most  property  is  borne  by  the  stock  com- 
pany for  a  consideration.  The  policyholder  thus  ex- 
changes an  uncertainty  for  certain  protection.  Many 
property  owners  will  prefer  this  situation  instead  of 
assuming  a  risk.  Then  too  it  is  impracticable  to  apply 


BUSINESS  ORGANIZATION  55 

the  mutual  principle  to  the  insurance  of  all  property. 
There  are  not  a  sufficient  number  of  properties  of  like 
character  to  make  possible  the  organization  of  a  mutual 
society  to  insure  each  class  of  property.  There  is  a 
very  wide  difference  in  the  hazard  of  the  same  kind  of 
property.  Mutual  insurance  organization  also  depends 
upon  a  well-developed  sense  of  cooperation,  and  this  is 
absent  in  many  people.  At  least  the  material  advan- 
tages of  cooperation  must  be  very  evident  to  persuade 
many  to  cooperate.  In  very  large  mutual  associations 
the  expense  element  is  likely  to  increase,  and  this  coun- 
teracts the  advantages.  Conflagrations  which  occur 
periodically  in  American  cities  would  often  seriously 
embarrass,  if  they  did  not  absolutely  prevent,  the  success 
of  the  mutual  principle.  It  must  not  be  forgotten  that 
the  cost  of  fire  insurance  is  essentially  a  cost  to  be  deter- 
mined by  future  events.  It  is  a  thing  sold  at  a  price 
fixed  in  advance,  that  is,  before  the  actual  cost  of  pro- 
duction or  cost  to  serve  is  known.  It  is  a  field  of  opera- 
tion for  the  risk  taker  and  there  is  no  probability  that 
the  stock  principle  will  not  continue  to  play  the  most 
important  role  in  supplying  fire  insurance  protection. 
In  1914  there  were  operating  in  the  United  States  three 
hundred  and  one  joint  stock  fire  and  marine  insurance 
companies  and  two  hundred  and  ninety-five  mutual 
organizations.  In  that  year  the  total  disbursements  of 
the  stock  companies  were  $356,319,704,  while  those  of 
the  mutual  companies  were  in  the  same  year  $42,615,354. 
Several  other  types  of  fire  insurance  organizations  are 
to  be  distinguished,  although  the  preceding  ones  are  by 
far  the  most  important. 


56  PRINCIPLES  OF  INSURANCE 

The  Lloyds.  —  There  are  many  different  fire  insurance 
organizations  known  by  the  name  of  Lloyd,  but  in  all 
cases  they  are  voluntary  partnership.  The  name 
"  Lloyds  "  arose  from  the  practice  in  the  seventeenth 
century  of  English  insurance  underwriters  assembling 
at  Edward  Lloyd's  coffee  house.  These  insurers  were 
individual  underwriters  and  chiefly  interested  in  marine 
insurance.  In  1774  the  Lloyds  transferred  their  place 
of  business  to  the  Royal  Exchange,  where  it  has  since 
remained.  In  1810  Parliament  appointed  a  com- 
mittee to  inquire  into  the  character  of  their  business,  and 
the  report  was  favorable  to  the  Lloyds.  In  1871  the 
Lloyds  were  incorporated  by  act  of  Parliament.  The 
organization  has  certain  rules  which  the  members  must 
obey,  but  the  business  of  writing  the  insurance  is  on  an 
individual  basis  and  for  the  benefit  of  its  members.  Each 
member  must  deposit  $5000  to  the  credit  of  the  trustees 
of  the  organization,  and  if  other  than  marine  risks  are 
underwritten,  additional  guarantees  are  required.  As  a 
business  organization  it  resembles  most  nearly  a  stock 
exchange.  Lloyds  are  chiefly  interested  in  marine 
insurance,  and  in  connection  with  this  work,  they  collect 
and  publish  a  vast  amount  of  marine  information 
through  their  publications,  such  as  Lloyd-List  and  Lloyd's 
Register,  the  latter  being  a  minute  description  of 
the  construction  and  rating  of  vessels.  Either  as  in- 
dividuals or  as  a  group  they  also  write  fire  and  other 
forms  of  property  insurance.  In  the  United  States  they 
secure  business  chiefly  through  the  insurance  broker. 
These  Lloyd  associations  in  England  and  in  continental 
countries  of  Europe  have  in  some  cases  very  large  re- 


BUSINESS  ORGANIZATION  57 

sources,  and  no  question  is  usually  raised  as  to  the  secu- 
rity of  the  protection  which  they  give.  However,  the 
name  Lloyds  in  the  United  States  is  usually  associated 
with  a  somewhat  different  class  of  organizations.  They 
are,  like  the  early  Lloyds,  associations  of  individual 
underwriters.  Some  of  them  have  been  responsible, 
but  many  have  been  of  a  quite  different  character. 
The  earlier  experience  with  such  associations  was  so  un- 
satisfactory that  many  states  have  enacted  legislation 
to  govern  their  organizations  and  operation.  In  New 
York  State  the  legislation  of  1910  and  its  subsequent 
modifications  brought  these  organizations  under  more 
strict  control.  The  lack  of  security  arose  from  the  fact 
that  these  associations  were  composed  of  individual 
underwriters,  each  of  whom  would  agree  to  take  a  part 
of  a  risk  or  in  some  cases  the  whole  of  it.  Manifestly 
the  ability  to  make  payments,  when  losses  occurred, 
depended  upon  the  personal  wealth  and  credit  of  the 
underwriter  unless  some  deposit  from  the  individual  or 
association  was  required.  In  1914  there  were  operating 
in  the  United  States  thirty  such  organizations,  known 
and  reporting  as  Lloyds. 

The  domestic  Lloyds  which  now  operate  do  so  either 
under  a  plan  of  unlimited  liability,  assumed  by  its  mem- 
bers, or  upon  a  specified  liability  assumed  by  each.  The 
foreign  Lloyds  are  not  permitted  to  have  agents  to 
solicit  insurance  in  some  states,  but  nevertheless  a 
certain  amount  of  insurance  is  written  by  them  in  the 
states  prohibiting  their  operation,  just  as  insurance  is 
not  infrequently  written  in  a  company  which  is  not 
admitted  to  do  business  in  a  particular  state.  It  has 


58  PRINCIPLES  OF  INSURANCE 

been  found  impossible  to  prevent  this  absolutely. 
The  property  owner  is  often  willing  to  take  whatever 
risk  may  be  involved  in  collecting  his  insurance  at  the 
time  of  loss  from  a  company  which  has  no  legal  status  in 
the  state  for  the  advantage  of  the  possible  lower  rate  at 
which  the  non-admitted  company  writes  the  business. 

Surplus  Lines.  —  The  laws  of  some  states  make  pro- 
vision for  what  is  called  "  surplus  line  of  insurance ; " 
that  is,  the  law  permits  insurance  to  be  written  in  "un- 
authorized companies  "  when  the  agent  and  the  prop- 
erty owner  make  affidavit  that  it  is  impossible  to  pro- 
cure sufficient  insurance  from  the  companies  authorized 
to  do  business  in  the  state.  In  the  large  cities,  where 
property  values  are  congested,  especially  in  such  a 
city  as  New  York,  there  is  always  a  certain  amount  of 
property  "  seeking  outside  insurance."  It  must  be 
understood  that  in  the  large  cities  it  is  often  difficult  to 
obtain  sufficient  insurance,  due  to  the  fact  that  no  com- 
pany will  take  to  exceed  a  certain  amount  of  insurance 
on  property  in  the  congested  districts.  This  is  espe- 
cially important  in  the  case  of  mercantile  stocks  or  con- 
tents as  compared  with  buildings.  Thus  the  situation 
may  arise  of  a  dearth  of  insurance  in  the  city,  just  as 
there  is  often  a  surplus  of  insurance  in  rural  districts. 

Inter-insurance  Organizations.  —  This  suggests  a 
second  minor  type  of  fire  insurance  organizations, 
viz.,  Inter-insurance  Associations.  These  organizations 
have  some  of  the  characteristics  of  the  mutual  associa- 
tions and  some  of  the  Lloyds.  They  are  composed 
chiefly  of  merchants,  associated  for  the  purpose  of  col- 
lectively insuring  each  other.  They  are  thus  mutual  in 


BUSINESS  ORGANIZATION  59 

character.  Each  merchant  or  member  agrees  to  be 
liable  for  a  certain  amount,  and  in  this  respect  they  are 
like  the  Lloyds.  They  are  thus  both  insurer  and  in- 
sured. Each  member  is,  as  it  were,  insurer  in  each  risk 
that  is  taken.  He  is  debited  or  credited  with  respect 
to  the  experience  on  each  risk.  Usually  the  premiums 
of  the  stock  companies  are  charged,  and  the  returns 
made  on  the  basis  of  the  experience  in  each  risk  amount 
to  a  partial  return  of  the  premium,  although  the  return 
may  not  be,  as  is  the  case  in  mill  mutuals,  directly  pro- 
portional to  the  premium.  Like  the  mill  mutuals  these 
inter-insurers  usually  confine  themselves  to  the  higher 
class  mercantile  risks,  that  is,  those  of  good  construc- 
tion, occupancy,  and  very  commonly  to  those  with  a 
sprinkler  equipment.  These  organizations  are  some- 
times called  reciprocal  insurance  organizations,  or  simply 
"  reciprocals,"  just  as  the  individual  underwriters 
may  be  called  Lloyds  or  simply  "  individual  under- 
writers." 

A  recent  type  of  organization  is  that  where  a  number 
of  companies  will  form  a  loose  union  to  write  certain  lines 
of  business,  especially  the  sprinkler  risks.  Or  a  very 
large  company  may  organize  a  separate  company  for 
the  purpose  of  writing  certain  lines  of  business  and  to 
take  from  the  parent  company  surplus  insurance. 
These  last  two  types  of  organizations  have  resulted  from 
the  competition  of  inter-insurance,  mutual  organizations, 
and  Lloyds,  which  often  took  from  the  stock  com- 
panies the  best  risks,  or  in  some  cases  because  the  large 
company  wished  to  control  the  whole  risk  instead  of 
insuring  it  in  some  competing  company. 


60  PRINCIPLES  OF  INSURANCE 

REFERENCES 

New  York  Insurance  Reports  (Fire  and  Marine),  1914. 

Report  of  the  Joint  Legislation  Commission  of  the  State  of  Penn- 
sylvania on  Fire  Insurance  Companies,  1915. 

Report  of  the  Joint  Committee  of  the  Senate  and  Assembly  of 
New  York  to  investigate  Insurance  Companies  other  than 
those  doing  a  Life  Insurance  Business,  1911. 

Yale  Readings  in  Insurance  (Fire). 

The  Business  of  Insurance,  Vol.  I. 

The  Insurance  Year  Book  (Fire),  1915. 

The  Insurance  Cyclopedia.    Walford. 


CHAPTER  IV 

THE   METHOD   OF    TRANSACTING   THE   BUSINESS   OF   FIRE 
INSURANCE 

The  Internal  Organization  of  a  Stock  Company.  — 

What  is  said  in  this  chapter  refers  chiefly  to  the  busi- 
ness of  the  stock  fire  insurance  company,  since  the  mutual 
associations  have  not  on  account  of  their  character  any 
complex  business  organizations.  After  the  company  has 
secured  its  charter  to  form  a  company  and  its  license  to 
write  insurance,  it  elects  its  board  of  directors,  who  select 
the  president  and  other  important  officials.  There  may 
be  several  vice-presidents,  each  in  charge  of  a  partic- 
ular department  of  insurance  when  the  company  writes 
several  different  kinds  or  "  lines  "  of  insurance ;  or  these 
vice-presidents  may  be  assigned  to  other  divisions  of  the 
business.  The  board  of  directors  through  its  committees 
concerns  itself  chiefly  with  the  financial  aspects  of  the 
business.  The  detailed  work  of  selecting,  inspecting, 
and  supervising  property  to  be  insured  as  well  as  the 
adjusting  of  losses  is  delegated  to  other  officials  and  em- 
ployees with  the  technical  knowledge  which  is  required 
to  transact  this  part  of  the  business. 

Necessity  for  an  Initial  Surplus.  —  A  fire  insurance 
company  must  for  reasons  to  be  explained  later  accu- 
mulate funds,  and  the  investment  of  this  money  requires 

61 


62  PRINCIPLES  OF  INSURANCE 

skill  and  foresight.  The  funds  under  their  care  are  nor- 
mally not  as  great  as  those  of  life  insurance  companies  since 
the  character  of  the  fire  insurance  contract  is  different 
from  the  life  insurance  contract.  No  such  large  funds 
belonging  to  policyholders  are  held,  but  the  directors 
and  officers  must  not  only  be  prepared  to  meet  the  cur- 
rent claims  resulting  from  losses,  as  in  a  life  company,  but 
they  must  also  be  in  position  to  pay  the  unexpected  losses, 
due  to  conflagrations  or  to  unfavorable  general  experience 
in  some  section  of  the  country.  A  life  insurance  com- 
pany can  always  know  in  advance  with  a  large  degree 
of  accuracy  how  much  it  will  be  necessary  to  pay  out  in 
losses  during  the  year,  and  hence  can  invest  its  funds  on 
the  basis  of  this  reasonable  certainty.  But  a  fire  insur- 
ance company  cannot  know  its  future  losses.  Its  losses 
may  fluctuate  considerably  from  year  to  year,  and 
hence  results  the  difference  in  the  problem  of  investing 
its  funds  in  order  to  have  on  hand  this  varying  amount 
to  pay  losses. 

Divisions  of  the  Organization.  —  The  business  organi- 
zation of  a  fire  insurance  company  usually  consists  of  the 
following  divisions : 

(a)  The  board  of  directors  who  with  the  president  and 
in  some  cases  the  vice-presidents  are  the  managers  of  the 
business. 

(&)  Home  Office  and  branch  office  employees,  who  are 
concerned  with  the  details  of  handling  the  business  after 
it  is  secured. 

(c)  The  Field  Force,  composed  of  General  Agents, 
Special  Agents,  Field  Men,  Inspectors,  and  Adjusters,  who 
secure  the  business  and  settle  the  losses. 


THE  BUSINESS  OF  FIRE  INSURANCE        63 

Home  Office  Organization.  —  The  work  of  group 
(a)  differs  somewhat  from  company  to  company  but  its 
general  character  has  been  sufficiently  indicated.  The 
organization  of  the  working  force  of  group  (b)  is  in  a  large 
company  composed  of  several  divisions  or  departments. 
Some  of  the  most  important  ones  are  the  examiners,  the 
loss,  the  cancellation,  the  reinsurance,  the  statistical,  the 
map  and  card,  the  abstracting,  and  the  mailing  depart- 
ments. When  a  policy  is  received  from  an  agent,  or  no- 
tice of  its  issue  is  sent  to  the  home  office,  it  is  referred  to 
the  examiner's  department  for  an  inspection  to  see  that 
the  contract  or  form  is  correct ;  that  the  rate  charged  is 
proper,  and  that  no  other  defect  is  present  in  the  policy. 
If  any  such  mistake  is  found,  the  agent  is  notified  to 
change  the  policy,  or  if  the  defect  is  serious  he  is  ordered 
to  cancel  the  policy.  In  the  process  of  examining  the 
policy  or  form,  the  map  department,  the  reinsurance,  the 
abstracting,  and  other  departments  are  called  upon  either 
for  information  or  for  the  purpose  of  recording  in  the 
office  the  detailed  information  about  each  risk  that  is 
accepted  by  the  company.  Not  only  are  all  details  of  the 
risk  itself  made  a  matter  of  record,  but  also  the  credit  of 
the  owner  as  disclosed  by  a  reference  to  such  mercantile 
credit  agencies  as  Dunn  or  Bradstreet.  In  short,  it  is 
the  purpose  of  this  examining  department  and  allied  de- 
partments to  make  certain  that  all  policies  conform  to  the 
laws  of  the  state  and  to  the  practice  of  the  company  in 
every  respect.  Any  one  of  many  hundred  provisions  may 
have  been  neglected  :  the  rate  may  be  too  low ;  a  permit 
to  use  a  hazardous  device  may  have  been  omitted ;  the 
property  may  be  in  a  congested  district  in  which  the 


64  PRINCIPLES  OF  INSURANCE 

company  already  has  its  maximum  amount  of  in- 
surance; the  risk  may  have  been  written  in  the  terri- 
tory of  another  agent.  Whatever  is  abnormal  in  the 
risk  is  supposed  to  be  discovered,  as  the  proposed 
policy  or  form  passes  through  the  various  departments 
for  inspection. 

The  Field  Force.  —  It  is  the  Field  Force  upon  which 
the  company  must  depend  for  its  business.  The  fire 
insurance  agent,  especially  the  local  agent,  occupies  an 
important  place  in  the  transaction  of  the  business.  It  is 
the  agent  who  comes  in  contact  with  the  insured,  selling 
for  the  company  the  commodity  and  often  rendering  large 
service  to  the  insured  in  adjusting  and  paying  the  loss. 
The  agent  is  legally  the  representative  of  the  insurer  but 
in  practice  he  often  renders  valuable  service  to  the  in- 
sured. 

Power  of  the  Early  Agents.  —  In  the  early  history  of  fire 
insurance  there  were  no  agents,  the  business  being  trans- 
acted directly  with  the  company  through  the  home 
officers.  This  method  had  been  in  practice  in  the  Euro- 
pean countries,  where  it  is  yet  very  general,  and  its  adop- 
tion by  the  early  companies  in  the  United  States  was 
a  natural  one.  The  European  companies  now  operating 
in  this  country  use,  however,  the  agency  system  of  the 
domestic  companies.  As  the  business  of  the  early  com- 
panies grew  in  volume  and  in  its  distribution  over  a  wide 
area,  the  practice  of  appointing  local  agents  as  represent- 
atives developed.  The  agent  in  the  United  States  had, 
however,  little  authority  before  1850.  He  received  the 
application,  which  was  sent  to  the  company,  whose  offi- 
cials accepted  or  rejected  it.  The  agent  at  first  usually 


THE   BUSINESS   OF   FIRE  INSURANCE        65 

represented  but  one  company  and  devoted  but  a  small 
part  of  his  time  to  the  business.  He  had  a  regular  busi- 
ness and  his  insurance  agency  work  was  supplementary 
to  this.  Many  examples-of  this  type  of  an  agent  are  yet 
found  in  the  villages  and  the  rural  districts.  However, 
as  the  cities  increased  in  population  and  in  property 
values,  the  local  agent  sometimes  found  he  sent  to  his 
company  a  greater  number  of  applications  than  they  were 
willing  to  accept.  That  is,  there  would  promise  to  be 
too  much  at  risk  in  a  single  place  either  on  account  of  the 
volume  of  business  or  because  some  of  the  risks  of  the 
agent  were  very  hazardous.  The  agent  therefore  made 
arrangements  to  represent  other  companies,  with  the 
result  that  an  agent  may  now  represent  several  companies 
among  which  he  distributes  his  business.  The  increase 
in  the  number  of  companies  and  the  resulting  competition 
for  business  also  furthered  the  tendency  of  the  agent  to 
represent  several  companies.  The  new  company  often 
preferred  to  appoint  a  man  who  was  already  an  insurance 
agent  instead  of  one  who  had  no  experience  and  no  busi- 
ness to  distribute. 

Relation  of  Agent  to  the  Company  and  Policyholder. 
-  The  policies  of  fire  insurance  run  from  one  to  five  years, 
and  hence  an  agent  has  policies  continually  expiring. 
Their  renewal  in  one  or  the  other  company  would  depend 
partly  upon  the  inducements  which  were  held  out  to  him 
in  the  form  of  commissions.  The  policyholder  very 
seldom  buys  fire  insurance  in  a  particular  company ;  that 
is,  he  does  not  usually  specify  a  particular  company. 
He  purchases  it  from  an  agent,  who  places  it  in  one  of  the 
several  agencies  which  he  represents.  Probably  a  major- 


66  PRINCIPLES  OF  INSURANCE 

ity  of  policyholders  in  fire  insurance  companies  could 
not  tell  without  investigation  with  what  company 
their  insurance  is. 

It  is  important  to  understand  the  position  which  the 
agent  occupies  both  with  respect  to  the  fire  insur- 
ance companies  and  to  the  policyholders,  because 
these  facts  are  at  the  basis  of  many  of  the  problems 
in  the  business,  such,  for  example,  as  the  commis- 
sion, the  rate,  the  brokerage,  and  other  questions. 

As  the  business  of  the  companies  developed,  two  other 
classes  of  agents  were  appointed,  viz.  the  General  Agent 
and  the  Special  Agent.  The  general  agent  was  appointed 
only  for  the  most  important  centers  and  was  given  charge 
of  the  business  in  a  large  section  of  the  country. 

Special  Agents.  —  The  special  agent  or  field  man  was 
appointed  with  the  growth  of  the  business.  These 
special  agents  are  direct  representatives  of  the  company. 
They  travel  over  the  territory  in  which  the  company 
writes  business,  calling  upon  the  local  agents,  aiding  them 
in  their  work,  and  acting  in  general  as  a  link  to  unite  the 
home  office  and  the  field  work.  In  the  earlier  period, 
when  there  were  no  schedules  or  rates  of  charges  for 
insuring  property,  these  special  agents  had  much  to  say 
about  the  rates  to  be  charged,  either  by  their  cooperation 
with  the  local  agent  or  with  the  associations  of  local 
agents.  These  special  agents  later  formed  associations 
such  as  the  New  England  Exchange,  formed  in  1883,  the 
Underwriters  Association  of  the  Middle  West,  and  other 
similar  organizations.  The  membership  in  such  associa- 
tions was  purely  personal.  The  chief  object  was  to  pre- 
serve harmony  among  companies,  their  agents,  and  the 


THE  BUSINESS  OF  FIRE  INSURANCE        67 

public.  They  did  not  directly  concern  themselves  with 
the  commission  of  agents. 

In  the  fire  insurance  business  friction  among  com- 
panies and  agents  has  not  been  infrequent.  Competition 
for  business  is  so  active  that  there  is  always  a  temptation 
to  cut  rates  of  commissions.  As  the  number  of  agents 
increased  and  as  rates  were  wholly  a  matter  of  under- 
writing judgment,  their  fluctuation  was  often  very 
marked. 

In  1866  the  National  Board  of  Underwriters  was  or- 
ganized. It  had  for  its  purpose  the  establishing  and 
maintaining  of  a  system  of  rates  of  premiums,  the  or- 
ganization of  local  boards  of  agents,  the  promotion  of 
harmony  among  the  insurance  interests,  the  suppression 
of  incendiarism,  and  the  encouragement  of  sound  under- 
writing. Between  1866  and  1877  the  National  Board  of 
Underwriters  established  and  controlled  the  rates  of 
premium  charges,  but  in  1877  this  power  was  transferred 
to  the  local  boards,  subject  to  the  restrictions  of  the 
companies.  This  Board  also  tried  to  secure  uniform 
practices  in  regard  to  the  commissions  paid  to  agents 
and  brokers.  By  1882,  when  the  conditions  in  refer- 
ence to  commissions  had  become  demoralized,  the 
attempt  was  abandoned. 

Organization  of  Agents.  —  As  the  number  of  general 
agents  increased,  organizations  composed  chiefly  of  them 
were  formed.  In  1879  the  Western  Union  was  formed. 
This  organization  was  composed  of  the  officials  of  the 
companies  and  concerned  itself  with  commissions  and 
rate-making.  Expert  rate-makers  were  employed  for 
this  purpose  but  in  1897  the  power  of  rate-making  in  this 


68  PRINCIPLES  OF  INSURANCE 

territory  was  generally  transferred  to  special  rating 
bureaus  or  inspection  bureaus.  ;;  In  some  states,  laws  had 
been  enacted  which  prohibited  the  companies  from  agree- 
ing upon  rates  through  their  associations  in  these  Unions. 
The  Western  Union  had  included  all  states  west  of  Ohio, 
Kentucky,  and  Tennessee  to  the  Rocky  Mountains. 
These  associations  made  up  of  competing  companies 
seemed  to  the  legislatures  a  method  of  restricting  de- 
sirable competition.  Some  companies  had  not  been 
members  of  these  Unions  which  were  formed,  and  these 
were  called  non-union  or  non-board  companies.  These 
companies  were  not  bound  by  the  agreement  of  the  Union 
companies  to  observe  the  uniform  rates  and  commissions 
paid  by  the  Board  companies.  Other  unions  were  formed 
in  other  sections  of  the  country.  In  twenty-four  states 
where  joint  action  is  prohibited  on  the  part  of  companies 
in  rate-making,  the  Inspection  or  Rating  Bureaus  do 
this  work  and  sell  their  service  to  the  companies.  The 
Unions  still  exist  in  different  sections  of  the  United  States 
with  their  territory  of  operation  delimited.  'They  con- 
cern themselves  with  matters  of  general  interest  to  the 
companies  which  are  members  of  the  Union.  Whether 
the  rates  are  made  by  representatives  of  the  company 
or  by  the  independent  rating  bureaus,  the  state  has 
developed  a  large  measure  of  supervision  over  the  charge 
for  fire  insurance.  Rates  are  therefore  made  by  the  com- 
pany itself,  by  representatives  of  a  number  of  companies 
in  a  Union  which  works  with  the  local  associations,  or 
by  the  independent  bureaus. 

In  addition  to  these  associations  of  agents,  there  are 
many  local  associations  of  underwriters.     These  have 


THE  BUSINESS  OF  FIRE  INSURANCE        69 

little  actual  power  over  rates  or  commissions.  They 
are  formed  to  encourage  proper  methods  of  conducting 
the  business,  to  further  a  more  intelligent  understanding 
of  fire  insurance,  to  reduce  the  fire  loss,  and  for  a  variety 
of  other  purposes. 

The  following  classification  shows  the  different  types 
of  Underwriter  Associations.1 


CLASSIFICATION  OF  ASSOCIATIONS 

According  to  — 

f  National 

(i)J  Jurisdiction j  Sectional-         f  Urban 

[  Local  \  Suburban 

(  Technical  and  educational  regu- 

(2)  Functions <      lation  of  brokers  and  agents 

[     and  rate-making 
Company  representatives 


(3)  Membership 


Occupation 

Special  agents 

of  mem- 

Agents and  brokers 

bers 

No  distinction  between  mem- 

bers 

i.  Without    qualifi- 

Classification 

Classified 

cation  of  vot- 

of mem- 

mem- 

ing  power 

bers 

ber- 

2.  With      qualifica- 

ship 

tion  of  voting 

power 

Adherence 

to  agreed  commis- 

Require- 

sions  to  agents 

,     ments 

Adherence   to   stated   scale   of 

brokers'  compensation 

1  A  survey  and  classification  of  Fire  Underwriter  Associations  in  the 
United  States.    Robert  Riegel,  The  Economic  World,  Nov.,  1915. 


PRINCIPLES  OF  INSURANCE 


The  following  outline  indicates  the  composition  and 
field  of  operation  of  some  of  the  more  important  Under- 
writers' Associations.1 


DATE 

OF 

OR- 

GANI- 
ZA- 
TION 

NAME  OF  ASSOCIATION 

EXTENT 
OF  JURIS- 
DICTION 

FUNCTIONS 

MEMBERSHIP 
COMPOSED 

OF 

1866 

Natl.  Bd.  of  Fire  Under- 

National 

Educational  work 

Companies 

writers 

Technical  studies 

1879 

Western  Union 

Sectional 

Formation  of  local 

Companies 

boards,      regula- 

tion    of     agents 

and    supervision 

of  rates 

Eastern  Union 

Sectional 

Regulation         of 

Companies 

agents,      promo- 

tion     of      good 

practices 

iSQ? 

Underwriters'     Associa- 

Sectional 

Regulation  of  bro- 

Companies 

tion  of  the  Pacific 

kers  and  agents, 

promulgation    of 

rates 

1889 

Rocky  Mountain  Fire 

Sectional 

Ditto 

Companies 

Underwriters'  Assoc. 

1882 

Southeastern  Tariff  As- 

Sectional 

Ditto  —  r-  Formation 

Companies] 

sociation 

of  local  boards 

l883 

New  Eng.  Ins.  Exchange 

Sectional 

Ditto 

Special 

Agents 

I883 

Underwriters'     Associa- 

Sectional 

Ditto 

Special 

tion  of  N.  Y.  State 

Agents 

l883 

Underwriters'      Associa- 

Sectional 

Ditto 

Special 

tion  of  the  Middle  De- 

Agents 

partment 

N.  Y.  Fire  Ins.  Exchange 

Local 

Regulation  of  bro- 

Agents and 

kers  and  agents, 

Brokers 

promulgation    of 

rates 

Philadelphia  Underwrit- 

Local 

Ditto 

Agents  and 

ers'   Association 

Brokers 

1  A  Survey  and  Classification  of  Fire  Underwriter  Associations  in  the 
United  States.    Robert  Riegel,  The  Economic  World,  Nov.  1915. 


THE  BUSINESS  OF  FIRE  INSURANCE        71 

The  Work  of  the  Agent.  —  The  agent  is  therefore  a 
very  important  part  of  the  fire  insurance  organization. 
It  is  he  who  decides  upon  the  risk,  although  the  company 
has  the  right  of  review.  But  the  company  is  dependent 
upon  him  for  the  amount  and  kind  of  business  which  it 
receives,  and  in  a  large  sense  for  the  terms  upon  which 
the  business  is  written.  He  has  it  very  largely  in  his 
power  to  make  or  mar  the  company.  It  is  to  be  under- 
stood that  he,  unlike  the  life  insurance  agent,  has  the 
power  to  issue  a  policy,  although  it  may  later  be  canceled 
by  the  company.  He  controls  in  a  purely  personal  man- 
ner a  large  amount  of  business  which  he  may  give  to  one 
or  the  other  of  the  several  companies  which  he  represents. 
The  policies  being  for  a  period  of  from  one  to  five  years 
are  continually  expiring  and  he  may  shift  the  business 
from  one  company  to  another  if  he  is  not  satisfied  with 
a  particular  company.  He  may  cease  writing  business 
for  a  particular  company,  and  this  company  will  often 
find  it  very  difficult  to  keep  this  old  business.  The  agent 
will  probably  be  able  to  take  it  with  him  to  his  new 
company,  for  his  business  is  largely  of  a  personal  char- 
acter. Most  companies  are  therefore  anxious  to  culti- 
vate the  good-will  of  the  agent  because  of  his  relative 
independent  position  with  respect  to  any  one  company. 
Legally  the  agent  is  the  representative  of  the  company, 
but  because  of  the  personal  character  of  his  business,  he 
is  solicitous  of  the  insured,  whose  business  he  desires  to 
control.  He  is  therefore  continually  anxious  to  satisfy 
the  insured  with  respect  to  charges,  policy  provisions, 
and  settlement  of  losses. 

This  peculiar  agency  relationship  explains  much  of  the 


72  PRINCIPLES  OF  INSURANCE 

conflict  in  the  fire  insurance  business  among  the  three 
parties  to'  the  contract,  the  insurer,  the  insured,  and  the 
agent.  It  is  remarkable  that  the  system  meets  with  as 
little  friction  as  it  does.  On  the  one  hand  companies 
are  anxious  to  secure  representation,  and  it  is  not  diffi- 
cult to  secure  an  agency  contract.  Agents  are  equally 
anxious  to  secure  a  large  number  of  companies  to  repre- 
sent, and  often  they  play  one  company  off  against  another. 
Property  holders  are  anxious  to  have  insurance  at  the 
lowest  possible  rates,  and  the  competition  of  the  com- 
panies with  each  other  for  the  agent's  business  not  in- 
frequently led  to  rate  wars,  to  insuring  bad  risks  at  low 
rates,  and  to  other  evils  of  a  system  of  excessive  com- 
petition. If  the  number  of  companies  and  agents  were 
materially  reduced,  and  if  cooperation  in  rate-making, 
commissions,  and  other  matters  were  enforced  under  the 
supervision  of  the  state,  property  holders  would  probably 
secure  their  fire  insurance  at  a  lower  cost. 

The  local  agent  makes  an  abstract  of  every  policy  he 
writes,  and  sends  it  to  the  company  in  the  form  of  a  daily 
report.  This  daily  report  includes  all  the  detailed 
information  in  reference  to  the  risk,  and  forms  the  basis 
of  acceptance  or  cancellation  of  the  contract  by  the 
company,  although  in  the  meantime  the  property  owner 
is  protected,  since  the  power  of  issuing  a  policy  is  inci- 
dent to  the  agency  powers  of  the  fire  insurance  agent. 
This  daily  report  is  therefore  necessary  in  order  to  pro- 
tect the  company.  At  the  close  of  each  month  the  agent 
sends  to  the  company  a  statement  of  all  business  trans- 
acted during  that  period,  and  settlements  with  the  com- 
pany from  the  agent  are  usually  based  upon  the  monthly 


THE  BUSINESS  OF  FIRE  INSURANCE        73 

business.  The  agent  also  has  power  to  cancel  policies. 
This  may  be  due  to  a  change  in  the  risk,  not  permitted 
in  the  policy,  to  the  discovery  of  a  moral  hazard,  or  to 
other  causes.  Notices  of  these  canceled  policies  are  also 
sent  to  the  company. 

The  Multiple  Agency  System.  —  A  recent  develop- 
ment in  the  agency  system  and  one  which  has  caused 
marked  difference  of  opinion  between  the  company  and 
the  agent  is  the  multiple  agency  system.  This  is  the 
system  under  which  a  single  company  will  have  in  the 
same  city  or  town  two  agents,  that  is,  two  distinct  repre- 
sentatives who  are  authorized  to  write  risks  for  the  same 
company.  The  second  agency  may  be  either  an  indi- 
vidual agent  with  his  subagents  or  in  some  cases  an  or- 
ganization such  as  an  Underwriters'  Association.  This 
development  is  another  product  of  the  excessive  com- 
petition which  characterizes  the  business  of  fire  insurance. 
Its  relation  to  competition  is  both  of  a  positive  and 
negative  character.  In  a  positive  sense  it  increases 
competition  in  that  two  distinct  agencies  of  the  same 
company  are  induced  to  adopt  all  the  methods  and  de- 
vices of  the  excessive  competition  among  companies, 
which  in  many  respects  expresses  itself  as  a  higher 
charge  for  fire  insurance.  This  is  ultimately  borne  by 
the  public.  Divided  responsibility  of  the  company  to 
the  policyholders  is  created.  Discrimination  is  en- 
couraged. Carelessness  in  writing  risks  is  induced.  The 
overhead  expense  of  transacting  the  business  is  in- 
creased. 

The  negative  aspect  of  the  multiple  agency  system 
is  found  in  the  fact  that  it  gives  an  added  advantage  to 


74  PRINCIPLES  OF  INSURANCE 

the  large  company  over  the  small  company.  At  present 
about  forty-three  per  cent  of  the  fire,  marine,  and  tor- 
nado business  is  transacted  by  twenty  companies.  The 
public  has  been  insistent  that  a  larger  number  of  com- 
panies be  in  business  and  has  sought  in  many  ways  — 
most  of  which  have  been  ill-advised  —  to  encourage  the 
organization  and  operation  of  additional  companies.  It 
will  be  shown  later  that  the  large  fire  insurance  com- 
panies have  in  some  respects  marked  advantages,  but 
there  are  also  good  reasons  to  encourage  the  existence 
of  small  companies  or  at  least  to  prevent  the  undue 
concentration  of  the  fire  insurance  business.  Not- 
withstanding the  great  financial  strength  of  the  large 
companies,  there  is  such  a  concentration  of  property 
values  in  the  American  cities  and  the  possibility  of  a 
conflagration  is  so  real  that  the  financial  strength  of  the 
largest  company  may  be  jeopardized  when  the  business 
is  not  properly  distributed.  Then  too  there  are  examples 
of  small  companies, — mutual  and  stock,  —  which  transact 
their  business  at  a  low  unit  cost,  and  no  assurance  can  be 
given  that  the  public  would  secure  better  or  cheaper 
protection  by  having  a  few  companies  transact  all  the 
business. 

Oregon  passed  a  law  in  1909  prohibiting  the  multiple 
agency  system  except  in  certain  circumstances,  and  the 
present  attitude  of  the  public  mind  towards  the  fire  in- 
surance organizations  is  such  that  it  will  not  .readily 
permit  an  undue  concentration  of  the  business  in  a  few 
companies. 

The  multiple  agency  system  not  only  encourages  the 
wrong  kind  of  competition  in  fire  insurance  and  dis- 


THE  BUSINESS  OF  FIRE  INSURANCE        75 

courages  the  desirable  kind,  but  it  also  decreases  the 
already  too  meager  responsibility  of  the  agent  to  the 
property  owner. 

The  Broker.  —  In  addition  to  the  insurance  agent, 
there  is  another  class  of  fire  insurance  solicitors.  These 
are  called  brokers.  The  broker  is  not  appointed  by  the 
company.  He  solicits  insurance  from  property  owners 
and  sells  to  the  companies  the  risk,  receiving  as  his  pay- 
ment a  commission  or  brokerage.  Brokers  are  found 
only  in  the  larger  cities,  and  in  some  of  the  largest  cities 
most  of  the  business  is  controlled  by  brokers.  The 
service  which  the  broker  renders  is  analogous  to  that  of 
the  agent,  especially  from  the  viewpoint  of  the  insured. 
He  is  not,  however,  in  a  legal  sense  the  agent  of  the 
insurer,  but  of  the  insured.  In  a  large  city  where  there  is 
a  surplus  of  insurable  property,  it  is  sometimes  difficult 
for  property  owners  to  find  insurance.  The  conditions 
of  the  risk  and  its  surroundings  are  often  very  complex. 
The  schedule  of  rates  is  difficult  to  understand  by  the 
property  owner.  The  broker  is  often  the  expert  for  the 
insured;  he  inspects  his  property,  suggests  changes  to 
be  made  to  secure  a  lower  rate,  and  renders  to  the  in- 
sured various  services  in  addition  to  securing  his  in- 
surance. To  render  this  complex  service  requires  a 
considerable  office  force,  and  this  can  only  be  supplied 
by  the  larger  brokerage  offices,  with  the  result  that 
most  of  the  business  in  large  cities  is  controlled  by 
these  large  offices.  This  is  the  description  of  the  broker- 
age system  in  its  best  form.  There  are  in  addition 
many  hundred  independent  single  brokers  who  solicit 
insurance  and  place  it  through  the  large  broker's  office, 


76 

or  directly  with  the  companies.  Brokers  of  this  class 
are  especially  likely  to  encourage  undesirable  competition 
for  the  business,  and  often  do  not  render  satisfactory 
service  to  the  property  owner.  These  small  brokers  are 
really  insurance  solicitors,  and  the  "brokerage  evil  " 
arises  chiefly  in  connection  with  their  operation.  It 
is  difficult  to  secure  agreements  to  comply  with  uniform 
practices  in  transacting  the  business.  No  capital  is 
required  to  enter  the  business,  and  consequently  some 
undesirable  men  are  drawn  into  it.  There  are  many 
examples  of  brokers  who  render  excellent  service.  On 
the  "other  hand,  there  are  others  who  are  interested  only 
in  the  commission  and  are  often  guilty  of  unfair  conduct 
both  to  the  public  and  the  insurance  company.  A 
small  percentage  of  brokers  give  their  full  time  to  the 
work.  They  lack  the  esprit  de  corps  of  the  business. 
They  secure  the  risk  and  sell  it  to  the  company  at  the 
lowest  possible  rate.  They  then  let  the  policyholders 
and  the  company  look  after  their  respective  interests. 
They  secure  the  full  and  often  the  unfair  advantages  of 
competition  in  the  business.  The  companies  themselves 
have  not  always  been  free  from  criticism  in  producing 
whatever  evil  there  is  in  the  present  situation,  since  it 
has  sometimes  happened  that  a  company  will  do  busi- 
ness with  a  broker,  disregarding  its  regularly  appointed 
agents.  This  results  largely  from  the  excessive  compe- 
tition which  has  existed  among  companies.  No  general 
approval  or  condemnation  of  the  brokerage  system  can 
therefore  be  given.  Where  the  brokers  have  a  large 
office  force  and  where  they  render  the  service  of  an  agent, 
that  is,  serve  both  the  policyholder  and  the  company 


THE   BUSINESS  OF  FIRE   INSURANCE        77 

in  ways  other  than  simply  writing  the  policy,  there  can 
be  no  great  objection  to  them. 

In  some  states  brokers  are  licensed,  and  are  thus  made 
more  responsible.  So  far  as  the  actual  work  of  the  best 
brokers  is  concerned,  his  services  to  the  insured  are  not 
greatly  different  from  that  of  the  agent.  But  their  rela- 
tion to  the  company  is  different.  In  a  sense  the  company 
cultivates  the  agent.  A  broker  cultivates  the  insured 
and  to  a  less  extent  the  company.  A  broker  has  a  risk 
and  seeks  to  get  the  best  terms  from  many  companies. 
An  agent  has  many  risks,  and  also  distributes  them 
among  the  companies  on  the  basis  of  various  considera- 
tions. A  broker  may  have  one  or  more  risks  too  large 
for  any  one  company  to  accept,  and  he  may  not  easily 
find  a  buyer  for  all  his  risks.  The  agent  is  not  in  this 
position.  If  a  company  is  disposed  to  be  too  independ- 
ent with  an  agent  in  accepting  the  risks  which  are 
offered  to  it,  the  agent  may  cancel  his  agency  con- 
tract and  secure  other  companies  to  represent.  This  is 
likely  to  be  especially  true  in  the  smaller  cities  and  the 
rural  districts  where  there  is  a  surplus  of  insurance,  and 
it  is  in  these  cases  where  the  agent  is  most  important, 
since  brokers  are  found  only  in  the  largest  cities. 

Steps  in  writing  a  Risk.  —  The  process  of  writing  a 
risk  by  an  agent  is  comparatively  simple.  He  solicits  the 
insurance,  and  consults  his  notebook  for  rates  and  rules, 
if  he  does  not  know  them.  If  there  is  no  rate,  he  con- 
sults with  the  district  superintendent,  agent,  or  rating 
bureau  to  get  a  rate.  He  then  issues  a  policy  in  one  of 
the  companies  which  he  represents.  He  has  in  his  pos- 
session the  policies  which  are  already  signed  and  become 


78  PRINCIPLES  OF  INSURANCE 

effective  so  soon  as  he  issues  them.  The  agent  then  re- 
ports the  fact  to  the  company  in  his  daily  report,  which 
is  a  notification  to  the  company  that  liability  has  been 
assumed.  An  abstract  of  the  policy  is  sent  to  the  com- 
pany for  examination.  The  company  may  find  some 
reason  to  order  the  policy  canceled.  If  it  does  not,  a 
complete  record  of  the  risk  is  made,  and  in  time,  usually 
regularly  on  a  monthly  basis,  the  agent  receives  his  com- 
mission. 

Commissions.  —  The  subject  of  commissions  has 
been  one  of  great  difficulty  throughout  the  history  of 
fire  insurance.  The  problem  has  several  phases  to  it. 
One  aspect  is,  how  much  commission  should  be  paid,  —  a 
question  upon  which  the  agents  and  the  companies  have 
disagreed.  Another  phase  is,  shall  commissions  differ 
in  amount  for  different  classes  of  business.  Another 
phase  is,  how  can  companies  be  induced  to  pay  the 
same  grade  of  commissions  to  agents  for  the  same  kind 
of  business.  Still  another  phase  is  the  public  one ;  that 
is,  the  interest  which  the  public  has  in  keeping  down  the 
expenses  by  limiting  commissions  to  a  fair  amount 
and  also  in  having  uniform  commissions  to  avoid  unjust 
discriminations  among  the  buyers  of  insurance. 

The  percentage  of  net  expenses  to  net  premiums 
written  by  the  joint  stock  companies  reporting  to  the  New 
York  Insurance  Department  was  in  1914  forty-three  and 
fifteen  hundredths  per  cent,  and  by  far  the  largest  item 
in  this  expense  is  the  commission  to  agents.  The  public 
is  therefore  interested  not  only  in  the  amount  paid  for 
commissions,  but  also  in  the  manner  in  which  it  is  paid. 
Many  of  the  companies  have  endeavored  by  agreement 


THE  BUSINESS  OF  FIRE  INSURANCE        79 

to  establish  fifteen  per  cent  as  the  normal  commission 
to  be  paid  to  agents  on  the  ordinary  business  and  in  all 
territory  other  than  that  of  the  large  cities.  This  was 
the  practice  of  the  board  or  union  companies,  that  is, 
companies  which  were  members  of  the  various  unions 
which  were  formed  for  this  and  other  purposes.  How- 
ever, some  of  the  largest  companies  have  refused  to  be 
bound  by  these  agreements,  and  other  newly  organized 
or  small  companies  did  not  observe  the  practice  of  the 
board  or  union  companies.  These  companies  might  offer 
higher  commissions,  and  since  the  agent's  reward  for  his 
work  is  in  commissions  alone,  this  appeal  to  him  has  often 
been  successful,  with  the  result  that  chaos  has  often  re- 
sulted in  the  matter  of  commissions.  Often  the  com- 
panies offering  the  higher  commissions  would  require  the 
agent  to  give  to  them  only  the  better  risks  under  his  con- 
trol, and  this  added  greater  confusion.  The  higher  com- 
mission became  an  inducement  for  the  agent  to  dis- 
criminate among  the  companies.  Some  companies 
would  have  an  unduly  large  number  of  poor  risks,  and  this 
in  final  analysis  expressed  itself  in  a  higher  rate  for  the 
property  holders,  in  addition  to  producing  an  unfavor- 
able return  for  the  stock  owners  of  the  company.  These 
high  commissions  may  also  have  caused  an  increase  in 
the  number  of  agents,  and  in  any  event  they  made  it 
difficult  to  preserve  uniformity  in  paying  for  the  work 
of  the  agent  which,  by  its  charatcer,  does  not  justify  any 
such  difference.  It  was  one  of  the  purposes  of  the  Unions 
to  secure  this  uniformity  but  they  have  not  completely 
solved  the  problem.  These  board  or  union  companies 
agree  upon  a  scale  of  commissions  varying  from  15  to  25 


8o  PRINCIPLES  OF  INSURANCE 

per  cent,  according  to  the  class  of  business,  except  in  the 
case  of  the  larger  cities.  In  general  the  plan  is  to  allow 
the  agent  these  graded  commissions  on  condition  that  he 
does  not  accept  an  agency  for  a  non-union  company. 
If  he  reserves  the  right  to  represent  one  of  these  non- 
board  companies  the  commission  is  fixed  at  15  per 
cent  with  an  allowance  of  one  per  cent  for  expenses. 
In  some  of  the  territory  of  the  unions,  an  agent  is 
not  permitted  to  represent  one  of  the  non-union  company 
companies.  Commissions  have  not  therefore  become 
standardized  and  probably  will  not  so  become,  until 
the  companies  are  compelled  to  cooperate  in  this  and 
other  related  matters  of  fire  insurance  in  which  the 
public  is  vitally  interested.  Indeed  there  has  been  a 
disposition  to  apply  the  anti-trust  laws  to  the  companies 
to  prevent  them  from  agreeing  upon  commissions  and 
rates.  The  public  has  been  disposed  to  think  that  the 
greater  the  competition  among  the  companies,  the 
greater  the  public  benefit.  But  no  other  one  thing  has 
been  so  responsible  for  the  high  expenses  of  companies 
as  the  unregulated  competition  which  has  characterized 
the  conduct  of  the  business.  The  non-union  companies 
are  larger  in  number  but  in  volume  of  business  they  are 
far  below  the  union  companies.  It  is  also  true  as  a  gen- 
eral statement  that  the  union  companies  are  the  strong- 
est and  most  conservative. 

Are  Commissions  too  Large?  A  favorite  method  of 
securing  business  by  a  fire  insurance  company  has  been 
to  cut  rates  and  increase  commissions  just  as  in  the  early 
days  of  the  railways,  the  traffic  was  often  solicited  by  a  re- 
duction in  charges  below  a  normal  point.  It  has  also 


THE  BUSINESS  OF  FIRE  INSURANCE        81 

been  argued  in  some  of  the  reports  of  legislative  com- 
mittees which  have  been  appointed  to  investigate  fire 
insurance  as  well  as  in  some  reports  of  Insurance  Commis- 
sioners, that  the  commissions  on  certain  classes  of  risks  are 
too  high.  This  usually  refers  to  such  risks  as  dwelling 
houses,  sprinkler  risks,  and  public  buildings  upon  which 
the  loss  ratio  is  often  lower  than  on  the  ordinary  risks. 
This  may  be  true,  but  until  there  is  a  more  detailed  analy- 
sis of  the  total  experience  on  different  classes  of  property 
as  a  whole,  it  is  difficult  to  prove  or  disprove  the  assertion. 
Contingent  Commissions.  —  Another  aspect  of  the 
commission  question  which  is  of  increasing  importance 
is  that  of  contingent  commissions  as  contrasted  with 
flat  and  graded  absolute  commissions.  The  contingent 
plan  of  paying  commissions  is  one  under  which  the  agent 
receives  a  flat  commission  at  the  time  of  writing  the  risk, 
and  an  additional  commission,  based  upon  the  fire  losses 
of  the  risks  he  writes,  that  is,  contingent  upon  the  profits 
of  the  agency.  The  purpose  is  clear  when  this  method  is 
compared  with  the  present  plan  of  paying  flat  commis- 
sions. It  would  place  a  premium  upon  the  carefulness 
and  fidelity  of  the  agent  to  the  interests  of  the  company. 
There  are  undoubtedly  many  agents  who  now  use  every 
care  in  selecting  risks  for  insurance,  but  it  must  be  ad- 
mitted that  there  is  in  the  present  system  much  which 
offers  an  inducement  to  be  careless  and  dishonest.  The 
agent  is  supposed  to  protect  the  company  against  accept- 
ing unduly  hazardous  risks,  resulting  either  from  the  char- 
acter of  the  property  or  of  the  owner  or  occupier.  If  he 
refuses  to  write  a  risk,  this  means  so  much  less  commis- 
sion for  him.  If  the  owner  of  the  property  wishes  to 
G 


82  PRINCIPLES  OF  INSURANCE 

buy  more  insurance  than  the  value  of  his  property,  the 
agent  will  receive  a  greater  return,  the  larger  the  amount 
of  insurance  is.  There  is  an  ever  present  inducement  for 
the  agent  to  be  dishonest,  or  at  least  to  be  irresponsible. 
Doubtless  most  of  the  fire  insurance  agents  are  not  con- 
sciously negligent  or  dishonest  on  account  of  this  fact, 
but  it  must  be  recalled  that  there  are  no  especial  qualifi- 
cations necessary  to  secure  an  agency  contract  and  that 
the  agency  force  is  very  numerous  with  a  considerable 
change  in  its  composition  from  year  to  year.  It  is  urged 
that  this  contingent  commission  plan  would  reward  the 
careful  agent,  penalize  the  dishonest,  and,  what  is 
most  important,  that  it  would  secure  a  marked  decrease 
in  the  abnormally  large  and  unnecessarily  great  loss  by 
fire. 

On  the  other  hand  it  is  argued  that  the  agents  are  not 
unfairly  rewarded  or  as  a  class  overpaid ;  that  any  plan 
of  contingent  commissions  which  puts  at  the  risk  of  a  fire 
a  large  part  of  the  agent's  commission  would  drive  out 
of  the  business  many  of  the  best  agents :  that  the  fire  in- 
surance agents  should  be  permitted,  as  are  other  citizens, 
to  sell  their  services  at  the  best  possible  price ;  that  there 
is  no  more  reason  found  to  justify  the  regulation  by  law 
of  the  wages  of  the  fire  insurance  agent  than  the  wages 
of  the  rank  and  file  of  other  wage  earners. 

There  is  no  immediate  prospect  that  there  will  be  a 
general  adoption  of  a  contingent  commission  system  of 
paying  the  agent. 


THE  BUSINESS   OF  FIRE  INSURANCE        83 

REFERENCES 

The  Business  of  Insurance,  Chap.  8. 

Report  of  the  Joint  Legislative  Commission  of  Pennsylvania  on 

Fire  Insurance,  1915. 
Report  of  the  Joint  Committee  of  the  Senate  and  Assembly  of 

New  York  on  Fire  Insurance,  1911. 
Report  of  the  Illinois  Fire  Insurance  Commission,  1911. 
Report  of  the  Fire  Insurance  Investigating  Committee  of  North 

Carolina,  1912. 
The  Relation  of  the  Company  and  Agent.    An  Address.    Friedrich 

W.  Day. 

The  Agency  System,  The  Hartford  Agent,  Vol.  I,  No.  2. 
From  the  Broker's  Standpoint,  Julian  Lucas. 


CHAPTER  V 

THE   HAZARD   IN   FIRE   INSURANCE 

Hazard  Defined.  —  The  term  "hazard"  in  fire  in- 
surance is  used  to  include  all  those  factors,  personal  and 
impersonal,  tangible  and  intangible,  which  affect  posi- 
tively or  negatively  the  chance  of  the  property  being 
destroyed  by  fire.  When  a  class  of  property  is  said 
to  have  a  high  or  low  hazard,  it  is  meant  that  each  of 
the  items  in  the  class  of  property  either  on  account  of 
the  construction  material  or  the  use  to  which  it  is  put 
or  for  some  other  reason  has  such  a  high  or  low  hazard 
as  to  make  it  representative  of  the  group.  The  charac- 
ter of  the  hazards,  therefore,  determines  the  character-  of 
the  risk  from  the  standpoint  of  its  chances  of  loss  by  fire. 
Hence  it  is  the  hazard  which  governs  the  rate  of  charge  for 
protection.  A  consideration  of  hazards  must  therefore 
precede  the  discussion  of  the  fire  insurance  rate. 

The  Hazard  in  Fire  and  Life  Insurance.  —  The  hazard 
in  fire  insurance  is  in  many  respects  different  from  that 
in  life  insurance.  Increase  in  age  in  life  insurance  means 
a  higher  charge  for  the  insurance,  but  this  does  not 
necessarily  happen  in  fire  insurance.  A  loss  is  certain  on 
every  ordinary  life  insurance  policy,  but  in  fire  insurance 
a  loss  may  or  may  not  occur.  The  factors  determining 
the  hazard  in  life  insurance  are  much  more  static  than 

84 


THE   HAZARD   IN   FIRE  INSURANCE         85 

those  in  fire  insurance.  The  hazard  of  a  single  risk  in 
fire  insurance  may  greatly  change  from  month  to  month, 
from  year  to  year.  These  factors  are  also  more  numer- 
ous in  fire  than  in  life  insurance,  and  they  are  more  be- 
yond the  control  of  the  individual.  The  business  of  fire 
insurance  is,  like  that  of  all  insurance,  based  funda- 
mentally upon  the  law  of  averages,  that  is,  upon  the 
assumption  that  the  hazard  in  its  largest  factors  can  be 
measured  and  that  there  will  be  found  a  regularity  in  the 
phenomena.  A  fire  insurance  company  by  an  analysis 
of  its  statistics  over  periods  of  years  and  in  different  sec- 
tions of  the  country  and  on  different  classes  of  property 
finds  that  a  certain  amount  of  property  burns  each  year. 
This  regularity  or  average  may  be  disturbed  by  conflagra- 
tions. There  is  nothing  in  fire  insurance  which  corre- 
sponds exactly  to  the  mortality  table  in  life  insurance, 
but  the  experience  of  companies  shows  a  burning  rate 
which,  while  fluctuating  considerably  from  year  to  year 
and  from  place  to  place,  yet  affords  a  rough  basis  for 
establishing  average  results. 

Notwithstanding  that  there  is  not  any  such  definite 
norm  in  fire  insurance  as  in  life  insurance,  according  to 
which  the  medical  examiner  judges  the  hazard  of  the  in- 
dividual risks,  there  are  standards  of  measuring  many  of 
the  hazards  in  fire  insurance.  The  inspector  or  rater 
and  other  individuals  who  endeavor  to  analyze  the 
hazard  of  risks  in  fire  insurance  do  essentially  what  the 
medical  examiner  does  in  life  insurance. 

Classification  of  Hazards.  —  The  most  important  and 
general  classification  of  hazards  are  Physical  and  Moral. 
Before  discussing  each  of  these  divisions,  it  is  necessary 


86  PRINCIPLES  OF  INSURANCE 

to  recognize  the  effect  on  hazards  of  the  elements  of 
place  and  time.  Since  hazard  has  to  do  with  the  causes 
affecting  favorably  or  unfavorably  the  burning  rate,  it 
is  evident  that  the  geographical  location  of  the  risks  will 
affect  this  rate.  This  may  be  due  in  part  to  a  difference 
in  climatic  conditions,  to  the  absence  of  rain,  to  the 
prevalence  of  frequent  high  winds,  to  long  periods  of  hot 
weather,  or  to  any  one  of  many  factors  which  produce 
the  higher  hazard  that  is  found  in  certain  localities.  The 
burning  rate  is  likely  to  be  higher  in  new  countries  and 
sections  than  in  long  settled  regions.  This  can  be  ex- 
plained in  part  by  the  character  of  the  construction  and 
other  evident  factors,  but  even  after  all  allowance  is 
made  for  the  known  factors,  there  is  not  infrequently 
left  a  difference  which  cannot  be  explained.  The  con- 
dition must  be  accepted  as  a  fact.  Selecting  states  at 
random  and  analyzing  their  burning  rate  over  a  period 
of  years  will  disclose  a  difference  that  is  difficult  to  ex- 
plain. This  has  a  very  important  bearing  upon  the  rates 
or  premiums  that  are  to  be  charged.  The  fire  insurance 
companies  have  found  it  difficult  to  take  into  considera- 
tion this  higher  burning  rate  in  certain  states.  Each 
state  wishes  to  have  as  low  rates  as  any  other  state,  and 
few  states  have  been  willing  to  permit  an  increase  of  rates 
even  when  a  conflagration  has  occurred  in  them.  The 
property  holders  of  Missouri  may  not  understand  why 
they  should  help  to  pay  the  losses  of  a  Baltimore  or  a  San 
Francisco  fire,  and  as  in  most  states,  they  are  prone  to 
resist  any  effort  on  the  part  of  the  companies  to  assess 
upon  them  the  losses  due  to  these  conflagrations.  Yet 
it  is  necessary  to  distribute  this  loss.  Maryland  and 


THE   HAZARD   IN   FIRE   INSURANCE         87 

California  property  holders  cannot  pay  it,  unless  it  is 
distributed  over  a  very  long  period  of  years,  and  this  is 
not  practical.  The  stockholders  of  the  companies 
cannot  be  expected  to  meet  such  unusual  losses.  The 
only  practical  and  just  method  is  to  distribute  it  over 
a  series  of  years  upon  all  property  holders.  Nor  should 
the  people  of  Missouri  object  to  this  method.  They 
have  no  assurance  that  a  similar  conflagration  will  not 
occur  in  St.  Louis,  when  they  will  be  very  anxious  to  have 
property  holders  in  other  states  aid  them.  The  capital- 
ist shareholder  will  not  and  cannot  pay  for  these  losses, 
and  the  only  method  is  to  distribute  them.  This  illus- 
trates again  the  mutual  character  in  final  analysis  of  fire 
insurance. 

Without  anticipating  the  future  discussion  of  this  topic, 
it  may  be  said  that  a  theoretical  fair  method  of  taking 
into  consideration  this  difference  in  normal  fire  losses  in 
different  sections  would  be  to  establish  the  rate  on  the 
basis  of  the  average  or  normal  burning  rate  with  an  addi- 
tion to  take  care  of  the  conflagration  losses  which  are 
likely  to  occur  in  any  section  of  the  country. 

The  Time  Element  in  Hazard.  —  The  time  element 
in  respect  to  the  hazard  is  even  more  difficult  to  explain 
than  the  place  element.  It  is  true  that  certain  months 
of  the  year  show  larger  losses  than  others,  but  there  is  a 
fluctuation  over  periods  of  years  which  is  not  accounted 
for  in  whole  by  the  conflagration  losses.  The  following 
tables  show  this  variation  in  losses  with  respect  to  the  ele- 
ment of  time. 


88 


PRINCIPLES  OF  INSURANCE 


FIRE   LOSSES   IN   THE   UNITED    STATES   AND  CANADA, 

1915 

January      ....    $20,060,000      July      ...'..  $9,006,800 

February    .'    :    .     .      13,081,250      August      ....  10,067,100 

March 18,786,400       September     ,     .     .  14,823,500 

April 18,180,350       October     ....  14,465,850 

May 11,388,450       November      .     .     .  21,204,850 

June       .     .    .     .    .      10,893,950      December.     .     .    .  20,877,100 


The  following  table  shows  the  annual  fire  losses  in  the 
United  States  for  forty  years,  1875-1914,  inclusive. 

ANNUAL   FIRE   LOSSES    IN   THE   UNITED    STATES    FOR 
FORTY  YEARS  —  1875-1914,  INCLUSIVE1 


YEAR 

AGGREGATE 
PROPERTY  Loss 

YEAR 

AGGREGATE 
PROPERTY  Loss 

187? 

$78,102,285 

189? 

$142,110,233 

1876        .  .  . 

64,630,600 

1896 

118,737,420 

1877 

'68,265  800 

1897 

Il6,3<;4  57? 

1878        .  .  . 

64..3I5  QOO 

1898 

130,503,  cxx 

1870 

77,  703  700 

1800 

iC2,t;Q7,8'?o 

iggo    

74,643  4.00 

IQOO          .   . 

160,020.  805 

1881         .  . 

81,280  900 

1901   

165,817  810 

Z882     

84..5O5  O2A 

IQO2 

161,078,040 

188* 

TOO  149  228 

IOO3 

14.  5  302  i^< 

1884 

no  008  611 

IQO4. 

229,198,050 

188? 

IO2  818,796 

IQO5 

165,221,650 

1886 

IOA  O24.  75O 

1906    

518,611  800- 

1887     .... 

I2O  28?  O55 

IOO7 

21  5,  084.,  700 

!888   

no  885  665 

IOO8 

217,885,850 

i8Sg   

1  23  .046.  8  3  3 

188,705,150 

1890 

108  003  702 

igiO    

214.  OO3.3OO 

1891    

IA3  76A.  06? 

2I7,OO4,575 

1892 

T  CT  ei6  008 

1912    

2o6  438  900 

1803 

l6?  54.4.  37O 

IOI3 

2O3,76?,55O 

1  80  A. 

14.0  006  4.8  A 

221,430,350 

1  These  figures  are  obtained  from  the  Records  of  the  Journal  of  Com- 
merce, deducting  the  Canadian  losses. 


THE  HAZARD   IN   FIRE  INSURANCE        89 

The  preceding  chart,  adapted  from  that  of  the  forty- 
ninth  annual  report  of  the  National  Board  of  Fire  Under- 
writers, shows  the  fluctuations  of  the  loss  ratio  through 
a  period  of  fifty-five  years.  Comparing  this  chart  with 
the  table  of  large  fire  losses  or  conflagrations  on  page  95, 
it  will  be  found  that  the  highest  peaks  are  to  be  explained 
by  these  conflagrations.  However,  after  all  allowance 
is  made,  the  fact  remains  that  the  changes  in  the  burn- 
ing rate  in  respect  to  time  and  locality  are  marked. 

It  is  not  to  be  concluded,  however,  that  the  law  of 
averages  and  the  principles  connected  with  it  are  of  no 
application  in  fire  insurance.  The  chief  difference  be- 
tween life  and  fire  insurance  in  this  respect  is  in  the  varia- 
tion ;  that  is,  in  fire  insurance  the  burning  rate  is  possible 
of  less  exact  prediction  than  is  the  mortality  experience 
in  life  insurance.  There  are  many  more  extremely 
variable  factors  and  more  factors  whose  force  cannot  at 
all  be  predicted.  These  elements  of  place  and  time  are 
not  hazards  but  largely  incalculable  factors  which  affect 
hazard. 

Physical  Hazards.  —  The  two  classes  of  hazards  have 
been  stated  to  be  Physical  and  Moral.  Physical  hazard 
may  be  subdivided  into  Construction,  Occupancy,  Protec- 
tion, and  Exposure  hazard.  It  will  be  recalled  that  in  the 
early  history  of  insurance  the  chief  hazard  considered 
was  the  construction  hazard.  Buildings  were  divided 
into  two  classes,  Brick  and  Frame.  These  two  divisions 
are  still  used,  but  many  elements  in  the  construction 
other  than  the  material  of  which  the  building  is  con- 
structed are  now  considered  in  determining  the  nature 
of  the  hazard  as  affected  by  construction.  Stone  and 


90  PRINCIPLES  OF  INSURANCE 

concrete  are  classed  with  brick  construction,  while  frame, 
iron-sheathed  frame,  skeleton  iron-clad  and  brick- 
veneered  buildings  are  classed  as  frame  construction. 
The  important  features  in  the  construction  which  affect 
the  hazard  are  the  height,  area,  walls,  roof,  ceiling,  sky- 
lights, openings  through  floors  and  partitions,  chimneys, 
flues,  exterior  attachments,  warerooms,  character  of  con- 
struction, and  conditions  of  the  material  of  construction. 
Height  of  Building.  —  The  height  of  a  building  affects 
the  hazard  chiefly  because  of  its  relation  to  fire  protec- 
tion. A  one-story  building  is  more  accessible  for  putting 
out  a  fire  than  one  of  many  stories.  The  hazard  does 
not,  however,  increase  directly  with  each  additional 
story.  The  absence  of  a  basement  affects  the  hazard 
favorably,  since  a  basement  is  a  place  where  refuse  accu- 
mulates and  where  inflammable  material  is  stored,  in  addi- 
tion to  the  fact  that  a  fire  breaking  out  in  the  basement 
is  likely  to  be  transmitted  rapidly  to  the  upper  stories. 
The  greater  the  area  of  the  building,  the  greater  the  haz- 
ard, because  of  the  additional  property  exposed  to  burning. 
The  walls  affect  the  hazard  both  in  respect  to  their  thick- 
ness and  to  their  prevalence  or  absence  as  division  walls. 
Insufficient  thickness  in  outside  walls  renders  them  liable 
to  weakening  by  fires  in  adjoining  buildings,  and  further, 
they  become  the  means  of  transmitting  fire.  Likewise 
division  walls  act  as  a  check  to  a  fire  which  breaks  out  in 
a  building.  They  also  add  strength  in  supporting  the 
floors  and  ceilings  of  the  building.  The  walls  should 
extend  above  the  roof  of  the  building  when  there  is  danger 
of  fire  from  adjoining  buildings,  since  they  act  as  a  pro- 
tection for  the  roof  and  roof  structures. 


THE   HAZARD   IN   FIRE  INSURANCE         91 

The  Roof.  —  The  character  of  the  roof  also  affects  the 
hazard.  The  shingle  wood  roof  so  common  in  the 
United  States  has  been  a  source  of  ignition  in  numerous 
cases,  especially  in  cities  and  towns  where  the  proximity 
of  buildings  has  contributed  greatly  to  the  hazard  from 
this  source.  Many  kinds  of  composition  roofing  have 
come  into  use  with  the  increasing  cost  of  lumber  and 
many  of  these  afford  good  protection  from  fire.  On  a 
brick  building,  the  slate,  metal,  tile,  or  one  of  these  ap- 
proved composition  roofings  is  accepted  as  standard. 
The  shape  of  the  roof  may  also  increase  the  hazard,  as, 
for  example,  a  frame  mansard  roof.  Composition  roof- 
ing should  be  used  on  the  flat  roof,  as  the  tar  which  may 
be  used  in  it  is  likely  to  run  down  on  sloping  roofs  and 
expose  the  lower  layers,  thus  increasing  the  danger  of 
ignition.  The  character  of  the  ceiling  and  wall  covering 
also  affects  the  hazard,  since  wood,  straw-board,  and 
canvas  more  readily  burn  than  the  metals  used  for  such 
purposes.  Skylights  or  openings  in  the  roof  may  be  an 
element  of  danger  in  the  construction  if  not  constructed 
of  wired  glass  properly  set  in.  Likewise  the  openings 
between  the  floors  are  important  as  a  means  of  fire 
spreading  from  one  floor  to  another.  Elevator  shafts  and 
stairways  become,  unless  properly  inclosed,  a  flue  to 
suck  up  the  fire  from  lower  to  upper  stories.  Self-closing 
doors  and  inclosed  elevator  shafts  are  used  to  reduce  the 
hazard  from  this  source.  The  character  of  the  material 
in  the  partition  of  a  building  or  in  the  floor  of  a  building, 
that  is,  whether  of  brick,  metal,  glass,  wood,  or  wood  and 
plaster,  also  affects  the  hazard.  Defective  flues  and 
chimneys  have  been  the  cause  of  so  many  fires  that  their 


92  PRINCIPLES  OF  INSURANCE 

proper  construction  for  the  purpose  of  reducing  the  hazard 
needs  no  discussion. 

Exterior  attachments  as  a  source  of  hazard  consist  of 
such  things  as  awnings,  roof  houses,  wood  cornices,  and 
similar  additions  to  the  regular  construction.  Ware- 
rooms  are  often  built  of  wood.  The  roof  may  be  bad. 
Fire  often  occurs  in  these  warerooms  or  storerooms  and 
endangers  the  main  building.  Many  other  features  of 
the  construction  favorably  or  unfavorably  affect  the 
hazard,  such,  for  example,  as  how  the  floors  are  laid, 
the  furnace  room's  construction,  the  foundation,  columns, 
and  beams  for  floor  support,  joist  construction,  and 
numerous  other  parts  of  the  construction.  Each  con- 
stitutes its  element  of  risk  or  safety. 

Occupancy  Hazards.  —  Occupancy  is  the  second 
division  of  the  physical  hazard,  and  this  refers  chiefly 
to  the  kind  of  business  transacted  in  the  building,  al- 
though the  manner  in  which  the  business  is  conducted 
with  respect  to  reducing  the  inherent  danger  of  fire  from 
the  nature  of  the  business  is  also  important.  If  refuse, 
waste  paper,  wrapping  material,  and  other  highly 
inflammable  substances  are  permitted  to  accumulate, 
an  unnecessary  element  of  risk  is  added  to  the  normal 
hazard. 

The  occupancy  hazard,  considered  in  its  relation  to  the 
material  in  the  building,  may  be  discussed  in  three  divi- 
sions. First,  as  a  medium  for  fire ;  that  is,  as  an  aid  to 
fire  both  in  its  intensity  and  in  spreading  the  fire  when 
once  it  is  started.  Material  may  have  low  or  high  com- 
bustibility. Hardware,  for  example,  has  low  com- 
bustibility, while  hay  has  high;  still  other  materials, 


THE  HAZARD   IN   FIRE  INSURANCE         93 

such  as  matches,  are  quasi  incendiary.  Second,  as  a  cause 
of  fire ;  that  is,  the  character  of  the  occupancy  with  re- 
spect to  the  probability  of  a  fire  being  started.  Build- 
ings used  for  offices  and  banks  have  occupancies  with  a 
very  little  hazard,  while  buildings  where  industrial  pro- 
cesses are  carried  on,  such  as  cleaning  and  dyeing  works, 
buildings  with  engines  and  machines  in  them,  have  a 
high  hazard.  Third,  as  an  effect  of  fire ;  that  is,  the  oc- 
cupancy may  be  of  a  kind  which  is  greatly  injured  in  the 
event  of  a  fire.  This  refers  to  the  damage  ability  of  the 
stock  or  occupancy.  Wool  ranks  low,  while  millinery 
ranks  high. 

In  the  classification  of  occupancy  hazards  of  the  Na- 
tional Board  of  Fire  Underwriters  the  following  classes 
by  groups  are  given.  Non-hazardous,  i-ioo,  Mercantile, 
101-298,  Manufacturing  Specials,  299-600,  Non-manu- 
facturing Specials,  601-700,  Miscellaneous,  701-800, 
Automatic-Sprinklered,  801-000.  It  will  be  observed 
that  occupancy  hazard  is  a  subject  of  great  importance 
in  fire  insurance  and  is  analyzed  in  great  detail. 

Protection.  —  The  third  general  division  of  physical 
hazard  is  protection.  This  is  divided  into  two  kinds, 
viz.,  public  and  private.  This  subject  will  be  discussed 
in  detail  in  the  chapter  on  Fire  Prevention,  but  at  this 
point  attention  may  be  directed  to  its  most  important 
aspects  as  it  affects  the  physical  hazard.  Public  pro- 
tection has  reference  to  the  waterworks,  the  fire  depart- 
ments, and  the  ordinances  and  laws  of  the  city  or  state. 
Cities  are  classified  according  to  the  excellence  of  these 
features.  One  city  may  have  a  large  water  supply, 
adequate  pumps,  large  water  mains,  high  pressure 


94  PRINCIPLES  OF  INSURANCE 

mains,  a  fire  department  with  adequate  physical  equip- 
ment, the  force  carefully  selected  and  free  from  political 
influence.  It  may  also  have  a  building  code  that  pre- 
vents the  erection  of  buildings  which  add  to  the  fire 
hazard  by  requiring  proper  construction  and  mainte- 
nance. This  is  done  in  a  variety  of  ways,  such,  for  ex- 
ample, as  preventing  the  use  of  shingle  roofs,  open  grat- 
ing on  the  sidewalk,  and  in  many  other  ways.  Private 
protection  is  concerned  with  fire  extinguishers,  watch- 
men, inside  standpipes,  sprinkler  equipment,  fire-es- 
capes, automatic  fire  alarms,  the  use  of  fireproof  paint, 
asbestos  covering  of  pipes,  and  many  other  devices  by 
which  the  protection  against  fire  may  be  increased. 

Exposure.  —  The  fourth  general  division  of  the  physi- 
cal hazard  is  Exposure.  This  is  an  important  element 
in  the  physical  hazard  on  account  of  the  fact  that  the 
larger  number  of  buildings  is  exposed  to  a  fire  from 
other  buildings.  Little  or  no  space  exists  between  build- 
ings in  the  cities,  and  even  the  width  of  the  average 
street  does  not  afford  protection  in  the  case  of  a  large 
fire.  The  Analytical  System  for  the  Measurement  of 
Relative  Fire  Hazard  divides  exposure  into  three  classes, 
viz.,  radiated,  absorbed,  and  transmitted ;  that  is,  a  build- 
ing may  send  out  to  other  buildings  a  part  of  its  own 
hazard ;  it  may  absorb  a  part  of  the  hazard  of  an  ad- 
joining building;  and  it  may  transmit  a  part  of  this 
absorbed  hazard  from  one  side  to  another  building  on  the 
opposite  side  of  it.  Manifestly  the  extent  to  which  a 
building  absorbs,  radiates,  and  transmits  a  hazard  de- 
pends upon  the  character  of  the  fire  protection,  the 
character  of  the  construction  of  its  walls,  and  the  ad- 


THE   HAZARD   IN   FIRE   INSURANCE         95 

joining  walls,  and  upon  the  distance  between  the  build- 
ings. If  the  fire  is  kept  in  the  building  by  means  of  good 
public  and  private  protection,  good  walls,  wired  glass 
or  iron-shuttered  windows,  the  exposure  element  be- 
comes unimportant.  If,  however,  the  fire  escapes  from 
the  building,  then  the  character  of  the  adjoining  walls, 
the  protection  of  the  openings  in  it,  the  width  of  space 
between  the  walls,  each  becomes  of  large  significance. 
When  the  buildings  are  of  different  height  or  length, 
other  elements  such  as  the  character  of  the  roof  and  the 
openings  in  it  assume  added  importance.  A  fire  wall 
between  two  adjoining  buildings  or  parts  of  the  same 
building  reduces  the  exposure  hazard  just  as  a  wide 
street  acts  as  a  preventive  to  the  spread  of  the  fire. 
Each  of  these  elements  in  the  physical  hazard  —  con- 
struction, occupancy,  protection,  and  exposure  —  is 
minutely  classified  and  is  sought  to  be  measured  in  the 
extent  to  which  it  contributes  to  the  hazard. 

The  Conflagration  Hazard.  —  There  remain  two  other 
aspects  of  hazard  which  cannot  easily  be  measured  and 
receive  their  pro  rata  cost  in  the  rates  charged  for  fire 
insurance.  These  are  the  Conflagration  and  the  Moral 
Hazard.  The  Conflagration  Hazard  refers  to  the  abnor- 
mal losses  by  fire  which  periodically  occur  in  the  cities 
of  the  United  States.  Some  of  the  largest  conflagrations 
which  have  occurred  in  the  United  States  are  as  follows : 

1914  Salem,  Massachusetts $14,000,000 

1908  Chelsea,  Massachusetts       12,000,000 

1906  San  Francisco,  California 350,000,000 

1904  Baltimore,  Maryland 50,000,000 

1901  Jacksonville,  Florida        11,000,000 

1872  Boston,  Massachusetts 75,000,000 


96  PRINCIPLES  OF  INSURANCE 

1871  Chicago,  Illinois $168,000,000 

1866  Portland,  Maine 10,000,000 

1 86 1  Charleston,  South  Carolina 10,000,000 

1851  San  Francisco,  California 25,000,000 

1835  New  York,  New  York 15,000,000 


Since  1850  there  have  been  in  the  United  States  seven- 
teen other  fires  in  cities  in  which  the  loss  was  between 
five  and  ten  million  dollars.  In  the  same  period  there 
were  two  hundred  and  nineteen  other  fires  in  which 
the  loss  was  from  one  to  five  million  dollars.  This  con- 
flagration element  in  the  hazard  introduces  a  difficult 
factor  to  measure  and  distribute  in  the  charge  for  fire 
insurance.  The  preceding  totals  indicate  what  a  large 
factor  it  is  in  the  charge,  but  they  do  not  indicate 
the  difficulty  of  assessing  the  cost  on  policyholders.  In 
the  first  place,  these  conflagrations  cannot  be  predicted, 
for  they  do  not  occur  with  a  stated  regularity.  In  the 
second  place  each  political  division  objects  to  having 
assessed  upon  it  the  past  or  prospective  charges  to  meet 
the  losses,  incident  to  these  conflagrations.  Even  if  to 
secure  the  average  loss,  a  long  period  of  years  is  taken, 
the  calculated  loss  over  this  longer  period  is  likely  to 
prove  an  unsatisfactory  guide  for  the  future,  because  the 
losses  are  not  equal  in  these  periodic  conflagrations.  As 
fire  insurance  is  administered  in  practice,  the  companies 
accumulate  a  surplus,  as  well  as  they  can  and  from  wher- 
ever they  can,  to  meet  the  heavy  losses  of  conflagration. 
This  is  usually  called  a  surplus,  a  subject  to  be  discussed 
later ;  but  if  the  public  and  the  company  would  set  aside 
a  fund  and  call  it  a  "  conflagration  reserve,"  there  might 
not  be  so  much  misunderstanding  as  to  the  real  purpose 


THE   HAZARD  IN   FIRE   INSURANCE         97 

and  nature  of  the  chief  part  of  the  surplus  which  a  fire 
insurance  company  accumulates.  It  is  essentially  a 
liability,  since  only  a  small  part  of  it,  as  judged  by 
past  experience  in  this  country,  is  a  potential  surplus ; 
that  is,  it  is  not  a  fund  to  be  considered  the  final  prop- 
erty of  the  stockholders.  The  stock  principle  of  con- 
ducting fire  insurance  is  in  this  connection  seen  to  have 
unusual  application.  These  large  "  surpluses  "  of  the 
strongest  stock  companies  seem  to  the  legislator  and 
taxing  officials  a  proof  of  the  ability  of  the  insurance 
company  to  pay  taxes,  although  the  fund  is  very  largely 
a  liability. 

Moral  Hazard.  —  There  is  still  another  kind  of  Hazard, 
viz.,  the  Moral  Hazard.  This  is  even  less  measurable 
than  the  conflagration  hazard,  since  it  relates  to  per- 
sonal characteristics.  The  phrase  "  moral  hazard " 
is  used  to  embrace  all  those  facts,  known  to  the  insured, 
which  at  the  time  of  taking  the  policy  and  during  its  con- 
tinuance result  in  a  larger  hazard  than  the  insurer  as- 
sumed for  the  premium  paid  for  the  policy.  These  per- 
sonal factors  cannot  be  reported,  analyzed,  or  measured. 
The  moral  hazard  expresses  itself  as  carelessness  in  using 
the  property  or  as  criminal  action  in  wilfully  setting  fire 
to  the  property,  or  in  misrepresenting  known  facts,  in 
overinsuring  the  property  with  the  intention  of  setting 
fire  to  it,  or  in  securing  a  lower  rate  than  that  to  which  the 
property  is  entitled.  The  moral  hazard  exists  whenever 
a  benefit  real  or  supposed  results  to  the  insured  or  a  bene- 
ficiary from  the  occurrence  of  a  fire,  or  whenever  anyone 
has  no  proper  desire  to  protect  the  property  against  fire. 
It  thus  includes  both  dishonesty  and  carelessness.  Finan- 


98  PRINCIPLES  OF  INSURANCE 

cial  embarrassments,  due  to  hard  times,  inefficiency, 
sickness  in  the  family  of  the  insured,  or  many  other  con- 
ditions may  often  result  in  an  increase  in  the  moral 
hazard.  There  seems  to  be  some  correlation  between 
the  number  of  fires  and  periods  of  industrial  depression, 
and  so  far  as  this  is  true,  it  is  largely  a  result  of  the  moral 
hazard.  Disputes  as  to  the  ownership  of  property  often 
increase  the  moral  hazard.  Difficulties  with  employees 
or  quarrels  with  other  persons  may  also  affect  the  moral 
hazard.  Likewise  the  use  of  property  in  a  manner  objec- 
tionable to  others  may  increase  the  moral  hazard.  How- 
ever the  moral  hazard  may  arise,  it  cannot  be  measured. 
Its  existence  is  not  usually  known  before  the  fere  occurs. 
In  some  cases  the  agent  discovers  what  he  considers  an 
increase  in  the  moral  hazard  and  orders  the  policy  to  be 
canceled ;  or  investigation  may  show  that  a  person  seek- 
ing insurance  has  in  the  past  had  suspicious  fires,  and  a 
policy  is  not  granted. 

Legal  Aspects  of  the  Hazard.  —  Some  of  the  more  im- 
portant legal  aspects  of  the  hazard  may  be  noticed  in 
concluding  the  discussion.  The  Standard  Policy  of  New 
York  states  "  this  entire  policy,  unless  otherwise  pro- 
vided by  agreement  indorsed  hereon  or  added  hereto 
shall  be  void  ...  if  the  hazard  be  increased  by  any 
means  within  the  control  or  knowledge  of  the  insured." 
This  is  a  condition  subsequent  which  in  insurance  law  is 
to  be  distinguished  from  a  condition  precedent.  In  the 
former  case  the  company  must  prove  in  its  defense  the 
violation  of  the  conditions  in  an  action  upon  the  policy, 
whereas  in  a  condition  precedent,  as  in  the  case  of  a  loss, 
the  insured  must  show  that  he  has  complied  with  all 


THE   HAZARD   IN   FIRE   INSURANCE         99 

the  conditions  before  he  is  entitled  to  a  right  of  action 
under  the  policy. 

The  hazard  is  supposed  to  remain  static  during  the 
time  for  which  the  policy  is  written,  the  rate  being  a 
charge  for  that  amount  of  hazard  which  the  risk  contains 
at  that  time.  If  there  is  an  increase  in  hazard  which  the 
insured  caused  or  which  is  within  his  knowledge,  he  se- 
cures more  protection  than  he  has  purchased.  The  fire 
insurance  contract  relies  upon  the  good  faith  of  the 
insured,  and  he  is  under  obligation  to  make  the  fact  of 
increased  hazard  known  to  the  insurer  in  order  that  the 
rate  may  be  adjusted  or  the  policy  may  be  canceled. 

It  is  manifestly  impossible  for  the  fire  insurance  com- 
pany to  keep  itself  informed  upon  the  changes  that  may 
occur  in  the  large  number  of  risks  which  it  has  insured. 
Failure  to  keep  the  property  in  a  good  condition  may  be 
held  by  the  courts  in  an  action  as  a  bar  to  recovery. 
The  policy  contains  clauses  for  contingencies  which  may 
arise  in  connection  with  the  risk  that  void  the  policy. 
These  are  in  practically  all  cases  a  change  in  the  hazard 
which  without  the  consent  of  the  insurer  act  as  a  void- 
ance  of  the  policy.  The  operation  of  a  factory  at  night, 
the  storing  of  explosives,  and  vacancy  are  examples  of 
a  change  in  hazard  which  voids  the  policy  if  the  insurer 
has  not  granted  permission.  The  early  forms  of  the  fire 
insurance  policy  provided  for  change  in  hazard  only  in 
general  terms ;  but  with  the  increase  in  different  kinds  of 
property  and  the  unfavorable  experience  with  juries, 
which  were  frequently  disposed  to  an  interpretation  and 
application  of  the  policy  in  a  manner  most  favorable  to 
the  insured,  the  companies  began  to  specify  in  great  de- 


ioo  PRINCIPLES  OF  INSURANCE 

tail  what  acts  and  uses  constituted  a  change  in  hazard. 
This  detailed  specification  of  increased  hazards  has  not 
served,  however,  to  prevent  many  contests  between  the 
insurer  and  insured  in  the  courts.  For  example,  the 
preceding  quotation  from  the  Standard  Policy  contains 
the  phrase  "  within  the  control  or  knowledge  of  the  in- 
sured." This  affords  an  opportunity  for  much  discussion 
and  difference  of  opinion.  If,  for  example,  the  insured 
learns  of  a  conspiracy  to  burn  his  property  but  has  not 
had  opportunity  or  time  to  so  inform  the  insurer,  before 
the  property  is  destroyed,  is  he  to  be  denied  the  right  of 
recovery  ?  It  is  to  be  noted  that  the  increase  in  hazard 
must  be  known  to  the  insured  and  within  his  control. 
The  hazard  of  many  risks  changes  from  time  to  time  as 
a  result  of  climatic  changes  or  for  other  natural  causes 
which  are  not  contemplated  under  this  clause.  It  has 
been  held  that  the  repair  of  a  force  pump,  although  tem- 
porarily increasing  the  hazard  of  the  risk,  did  not  operate 
to  void  the  policy  if  the  repairs  were  made  within  a  rea- 
sonable period.  (Townshend  vs.  Northwestern  Insurance 
Co.,  1 8  N.  Y.  1 68.)  A  small  quantity  of  petroleum  kept 
for  medical  purposes,  but  kept  continually,  was  held  to 
void  the  policy,  notwithstanding  that  it  was  not  the  cause 
of  the  fire.  (Williams  vs.  Peoples  Fire  Insurance  Co., 
57  N.  Y.  274.)  The  weight  of  authority  seems  to  be  that 
any  temporary  increase  of  the  physical  hazard  does  not 
act  ordinarily  as  a  forfeiture  of  the  policy.  The  change 
must  be  of  a  permanent  character ;  that  is,  either  in  re- 
spect to  a  different  use  of  the  property  or  in  respect  to  the 
property  itself.  It  has  been  held,  for  example,  that  where 
the  insured  erected  other  buildings  adjoining  his  pre- 


THE  HAZARD   IN   FIRE   INSURANCE        101 

viously  insured  building  that  the  policy  became  void 
because  there  had  been  an  increase  of  hazard.  Both 
the  insurer  and  the  insured  have  attempted  in  the  courts 
to  make  very  fine  distinctions  in  reference  to  this  ques- 
tion of  what  constitutes  an  increase  in  hazard,  but  on  the 
whole  the  courts  have  been  disposed  to  apply  this  part 
of  the  policy  according  to  its  spirit,  and  not  its  letter. 
The  hazard  constitutes  the  very  essence  of  the  fire  in- 
surance contract,  and  demands  from  both  parties  the 
utmost  good  faith.  The  insured  wishes  his  indemnity 
when  the  loss  occurs.  The  insurer  wishes  a  premium  to 
be  paid  which  is  an  expression  of  the  real  hazard.  Dis- 
honesty on  the  part  of  either  defeats  the  real  interests  of 
both  parties. 

REFERENCES 

Philosophy  and  Method  of  Operation  of  the  Analytical  System. 

H.  M.  Hess. 

Building  Construction.     Frederick  C.  Moore. 
Classification  of  Occupancy  Hazards.    National  Board  of  Fire 

Underwriters. 

Fire  Rating  as  a  Science.    A.  F.  Dean. 
Report  of  the  National  Board  of  Fire  Underwriters,  1915. 
Increase  of  Hazard.    Hartwell  Cabell.    The  Insurance  Society  of 

New  York. 
The  Insurance  Year  Book,  1915. 


CHAPTER  VI 

RATES   AND   RATING 

The  Rate  Defined.  —  The  rate  in  fire  insurance  is  the 
amount  paid  per  $100.00  of  insurance  value  of  the  prop- 
erty ;  that  is,  the  rate  is  quoted  as  a  40  cent,  a  50,  or  a  60 
cent  rate,  meaning  that  $100.00  of  insurance  is  granted 
for  this  sum.  It  may  be  based  on  a  one,  two,  three,  or 
five-year  period  or  on  a  period  less  than  one  year.  In 
this  last  case,  the  rate  is  called  a  "  short-term  rate." 
Unless  otherwise  specified,  the  rate  is  quoted  on  a  one- 
year  basis.  It  corresponds  somewhat  to  the  ordinary 
tax  rate  in  which  the  tax  is  stated  as  so  many  cents  on  the 
$100.00  worth  of  property.  A  rate  is  said  to  apply  to  a 
specific  risk  or  to  a  class  of  risks,  as  for  example  to  a  drug 
store  or  to  dwelling  houses.  In  the  first  case  the  rate 
differs  for  each  risk.  In  the  second  case  the  rate  applies 
to  each  dwelling  house  and  is  the  same  except  as  it  varies 
on  account  of  difference  in  the  construction  material 
and  exposure  in  some  localities.  In  the  one  case  there 
is  an  analysis  of  the  hazard  of  each  risk  for  the  purpose 
of  determining  its  particular  rate,  while  in  the  other 
case  the  rate  is  considered  to  be  representative  of  the 
hazard  of  the  class  of  buildings.  The  amount  of  the 
hazard  in  either  case  determines  the  amount  of  the  risk 
and  hence  the  rate.  The  only  difference  in  the  preced- 


RATES  AND   RATING  103 

ing  examples  is,  that  there  is  in  the  first  case  an  individ- 
ualizing and  a  more  complete  analysis  of  the  hazard. 

Preferred  Risks.  —  The  terms  "  preferred  "  and  "  non- 
preferred  "  risks  were  formerly  much  in  use,  the  former 
being  those  which  had  a  low  loss  ratio  and  the  latter 
those  which  had  a  heavy  loss.  This  classification  of 
risks  is  not  of  great  present  importance  on  account  of  the 
development  of  more  scientific  methods  of  determining 
the  rate.  If  the  hazard  incident  to  each  risk  or  class  of 
risks  is  properly  discovered  and  analyzed  and  therefore 
a  rate  derived  which  measures  the  cost  of  the  fire  protec- 
tion, then  one  risk  or  class  of  risks  ought  not  to  be  pre- 
ferred to  another.  This  is  a  point  in  the  development  of 
scientific  rating  which  has  not  yet  been  completely  reached , 
but  sufficient  progress  has  been  made  to  cause  the  old  use 
of  preferred  risks  to  have  little  significance.  Risks  are, 
however,  frequently  classified  as  Ordinary,  Fire-proof, 
and  Sprinklered.  It  will  be  recalled  from  the  past 
discussion  how  important  the  early  classification  of  risks 
into  brick  and  frame  was.  This  is  yet  important,  for1 
the  complicated  system  of  tariffs,  found  in  schedules  for 
fire  rating,  use  what  is  called  a  brick  and  a  frame  schedule. 

The  Rate  as  a  Source  of  Disagreement.  —  The  rate  is 
the  subject  about  which  most  discussions  in  fire  insur- 
ance center,  both  because  it  is  the  price  for  the  consumer 
and  also  because  of  the  opportunity  to  compare  these 
prices  by  different  consumers.  On  the  part  of  the  public 
there  is  a  very  little  accurate  knowledge  as  to  the  nature 
and  purpose  of  fire  insurance.  The  average  person 
considers  it  in  much  the  same  light  as  he  does  any  com- 
mon subject  of  sale  and  purchase.  He  assumes  that  he, 


104  PRINCIPLES  OF  INSURANCE 

may  go  into  the  market  and  purchase  as  much  or  as  little 
as  he  chooses  at  so  much  per  unit  of  measurement.  He 
confuses  it  with  life  insurance,  concerning  which  he  has 
gained  considerable  knowledge  during  the  last  decade. 
He  purchases  as  much  life  insurance  as  his  saving  power 
enables  him.  But  fire  insurance  has  no  direct  relation  to 
saving,  but  should  always  be  a  question  of  indemnity 
for  property  loss.  The  individual  demand  cannot  be 
measured  in  fire  insurance  by  the  ability  and  desire  to 
purchase,  but  must  be  limited  by  the  value  of  property 
possessed ;  whereas  in  life  insurance  full  operation  of 
effective  individual  demand  may  be  permitted,  except 
as  it  is  limited  by  the  physical  condition  of  the  appli- 
cant, or  a  maximum  limit  of  insurance  in  a  particular  com- 
pany. That  is  to  say,  an  individual  in  normal  health 
could  purchase  without  injury  to  the  business  or  to  other 
people  all  the  life  insurance  he  desired ;  but  the  amount  of 
fire  insurance  which  he  should  be  permitted  to  purchase 
should  be  limited  by  the  value  of  his  property. 

The  Theoretical  Bases  of  the  Rate.  —  The  simplest 
statement  of  the  theory  of  fire  insurance  rates  is  that 
the  rate  is  a  resultant  of  the  property  loss,  the  expense 
element,  the  maintenance  of  the  reserve  required  by  the 
various  state  laws,  and  a  provision  for  a  return  on  the 
capital  invested.  The  interest  rate  is  over  considerable 
periods  of  time  a  relatively  constant  factor.  It  is  the 
property  loss  element  in  the  final  cost  which  fluctuates. 
This  property  loss  is  for  any  one  year  an  indeterminate 
and  largely  an  independent  variable.  The  burning  rate 
is  always  in  process  of  change,  and  the  range  of  it  on  an 
annual  basis  is  sometimes  very  great.  The  fluctuation 


RATES  AND  RATING  105 

for  a  year  in  the  total  loss  ratio  may  vary  as  much  as 
20  per  cent,  and  the  loss  ratio  on  particular  kinds  of 
property,  or  upon  all  classes  of  property  in  particular 
regions,  may  vary  much  more.  Yet  rates  for  the  fu- 
ture —  since  fire  insurance  is  a  service  sold  for  future 
delivery  —  must  be  determined.  In  many  manufactur- 
ing and  mercantile  businesses  the  selling  price  is  an  ex- 
pression of  the  expenses  of  production  with  such  addi- 
tion as  the  producer  may  be  able  to  add  in  the  nature 
of  profit.  But  what  is  a  proper  rate  in  fire  insurance, 
that  is,  what  is  a  proper  price  from  the  standpoint  of  the 
seller  —  the  insurer  —  and  the  buyer  —  the  insured 
—  is  a  question  difficult  to  determine. 

Classification  and  Rates.  —  It  is  a  common  doctrine 
in  determining  prices  that  each  article  should  express  in 
its  selling  price  its  total  expenses  of  production.  It  is 
therefore  assumed  by  those  who  have  not  given  careful 
thought  to  the  determination  of  fire  insurance  rates,  that 
all  that  is  necessary  in  applying  this  principle  to  fire  in- 
surance is  to  classify  the  fire  loss  in  each  industry  and  pro- 
rate this  loss  on  each  individual  item  of  the  class.  This 
is  the  system  of  classification  for  determining  the  fire 
rate.  There  have  been  urged  two  aspects  or  reasons  for 
classification.  First,  the  classification  of  properties  ac- 
cording to  the  character  of  the  industry  or  use  to  which 
the  property  is  placed.  That  is,  drug  stores,  flour  mills, 
and  other  similar  classifications  can  be  made,  so  that  the 
loss  on  drug  stores  by  fire  would  express  itself  in  the 
price  of  the  product  sold.  In  theory  the  same  could  be 
done  for  all  other  industries.  Second,  that  the  fire 
loss  should  be  classified  according  to  political  divisions ; 


io6  PRINCIPLES  OF  INSURANCE 

that  is,  the  fire  losses  in  New  York  should  be  borne  by 
the  people  of  that  state  and  likewise  in  all  other  states. 
Each  of  these  ideas  seems  to  have  great  plausibility, 
and  it  is  necessary  to  examine  them  carefully  to  disclose 
the  fallacy  both  from  the  standpoint  of  their  practica- 
bility as  well  as  to  their  theoretical  justification.  That 
each  product  should  bear  its  total  costs  of  production  is 
generally  admitted,  and  in  so  far  as  fire  insurance  is  a 
part  of  this  cost,  it  ought  to  be  borne  by  the  product 
with  the  following  important  modification.  Insurance  is 
in  all  its  divisions  an  essentially  cooperative  device  by 
which  burdens  of  different  kinds  are  distributed  among 
a  group.  The  money  paid  out  at  any  one  time  in  loss 
payments  has  been  collected  from  various  sources  and 
various  industries.  At  any  one  time  the  price  of  a  par- 
ticular product  may  carry  in  it  an  insurance  element 
which  will  be  used  to  pay  losses  of  another  producer  or 
on  another  product  of  some  other  industry  or  for  the 
losses  suffered  by  producers  of  the  same  product  in  other 
sections  of  the  country.  Likewise  when  a  later  loss 
occurs  to  the  producers  of  a  particular  commodity, 
they  will  be  indemnified  by  the  insurance  element 
in  the  price  of  other  producers'  products.  The  in- 
surance charge  is  one  for  future  contingencies,  and 
it  cannot  be  prorated  in  the  prices  of  present  com- 
modities in  the  same  manner  as  prices  for  raw  materials 
or  for  labor. 

Classification  on  the  Basis  of  Industry.  —  Let  us  notice 
further  what  classification  with  respect  to  industries  im- 
plies. It  implies  a  fundamental  error  in  that  it  assumes  a 
sameness  in  risks  of  the  same  industry,  when,  as  a  matter 


RATES  AND   RATING  107 

of  fact,  risks  are  very  complex  in  the  same  industry.  This 
error  results  in  part  from  a  confusion  of  fire  risks  and  life 
insurance  risks.  In  life  insurance  there  is  a  mortality 
table  and  a  classification  of  lives  on  the  basis  of  age  and 
physical  vigor  in  respect  to  the  known  facts  of  this  mortal- 
ity table.  There  are  no  partial  losses  in  life  insurance, 
whereas  in  fire  insurance  the  greater  number  of  losses  are 
partial.  There  is  no  certain  expectancy  of  life  in  respect 
to  a  fire  risk.  In  fire  insurance  the  risk  is  composed  of 
and  affected  by  a  large  number  of  heterogeneous  factors, 
whereas  in  life  insurance  the  risk  is  more  homogeneous, 
and  the  factors  affecting  it  can  be  classified  and  their 
force  calculated.  For  example,  a  drug  store  in  one  city 
may  have  a  hazard  many  times  that  of  a  drug  store  in 
another  city.  The  first  drug  store  may  be  on  the  ground 
floor  of  a  building  of  several  stories,  the  upper  floors 
being  occupied  by  a  tailor  shop,  a  millinery  store,  and 
dwelling  apartments.  The  other  drug  store  may  be  lo- 
cated in  a  one-story  building.  Each  may  be  constructed 
of  the  same  material  and  each  used  by  an  equally  careful 
occupier ;  or  one  may  be  frame  and  the  other  brick ;  or 
one  may  be  in  a  city  with  good  fire  protection  and  the 
other  in  a  city  with  a  poor  fire  department  and  water 
works.  One  may  have  a  good  roof,  the  other  a  poor  one. 
There  is  an  endless  number  of  combinations  which  may 
be  suggested  which  would  make  the  risks  different.  Each 
risk  has  its  inherent  hazard,  due  to  the  nature  of  the  oc- 
cupancy, but  even  this  is  only  one  of  the  numerous  haz- 
ards which  make  up  the  complete  hazard  of  the  risk. 
If  the  principle  of  classification  was  carried  to  its  logical 
conclusion,  there  would  be  many  classifications  in  each 


io8  PRINCIPLES  OF  INSURANCE 

single  industry ;  that  is,  in  the  case  of  drug  stores  there 
would  need  to  be  a  class  for  one-story  drug  stores  of  frame 
and  of  brick,  of  drug  stores  with  careful  occupiers,  with 
no  adjoining  buildings,  of  adjoining  buildings  of  particu- 
lar kinds,  with  a  wide  street  and  a  narrow  street  between 
them  and  other  property  across  the  street,  and  so  on  ad 
infinitum.  Such  classification  carried  to  its  logical  end 
would  be  absurd  and  would  form  no  data  for  the  deter- 
mination of  fair  insurance  charges.  There  would  be  no 
basis  for  the  determination  of  the  charge  in  each  class. 
Even  if  a  minute  classification  was  made  of  experience 
in  each  industry,  the  results  would  not  be  of  any  value 
for  the  future,  because  the  facts  would  have  changed. 
Such  classification  would  be  history,  a  record  of  the  past. 
Changes  in  building  material,  construction,  protection, 
and  many  other  conditions  affecting  the  hazard  of  each 
risk  or  class  of  risks  are  continually  made.  So  that  by 
the  time  each  set  of  new  changes,  even  supposing  they 
could  all  be  expressed  in  the  classifications,  was  made, 
other  changes  would  have  occurred,  nullifying  all  the  past 
work.  Even  if  a  rate  could  be  devised  for  a  class,  it 
would  be  only  an  average  rate,  and  like  all  averages  it 
might  not  be  the  exact  rate  for  a  single  risk  in  the  class. 
Such  a  classification  of  risks  on  the  basis  of  occupancy 
alone  would  have  little  more  significance  for  a  fire  insur- 
ance company  for  rate-making  purposes*  than  a  classi- 
fication of  persons  according  to  their  names  or  the  color 
of  their  hair  would  have  for  a  life  insurance  company. 
Any  classification  of  risks  to  be  of  value  for  rate-making 
purposes  must  be  based  upon  the  complete  hazard  of  the 
risks. 


RATES  AND  RATING  109 

Classification  on  the  Basis  of  Political  Divisions.  — 

Classification  in  the  second  place  is  often  considered  on 
the  basis  of  the  political  division.  Concretely  this  takes 
the  form  of  the  inquiry  why  the  property  owners  of  one 
state  should  not  have  their  fire  insurance  rates  determined 
by  the  losses  in  that  state.  This  aspect  of  classification 
often  does  not  refer  to  the  rate  on  different  classes  of  prop- 
erties. Assuming  that  rates  have  been  accurately  de- 
termined, is  there  any  reason  why  the  people  of  Missouri 
should  pay  for  the  losses  in  Illinois?  There  is  a  grow- 
ing sentiment  to  insist  that  rates  be  based  upon  the 
classified  experience  of  losses  in  that  state,  and  under 
proper  limitations  this  principle  may  be  accepted.  The 
chief  limitation  arises  in  connection  with  conflagrations 
and  certain  local  and  state  expenses  in  particular  states. 
As  regards  conflagrations  it  should  be  recognized  that  no 
state  is  proof  against  them,  and  when  such  heavy  losses 
do  occur,  the  property  holders  may  very  properly,  in 
harmony  with  the  mutual  character  of  insurance,  expect 
the  past  and  future  payments  by  policyholders  in  other 
states  to  aid  in  paying  these  unusual  losses.  It  is  an 
extra  charge  which  may  very  properly  be  distributed 
over  a  series  of  years  and  upon  a  large  number  of  prop- ' 
erty  holders  to  the  interest  of  all  concerned.  Concretely 
it  is  a  question  whether  it  was  possible  or  desirable  for 
the  people  of  California  to  pay  the  heavy  loss  of  the  San 
Francisco  fire  or  whether  a  slight  additional  to  the  normal 
charge  of  protection  to  property  owners  in  the  country  at 
large  would  not  be  the  better  method  of  raising  the  large 
fund  for  this  unpredictable  loss.  Assuming,  therefore, 
that  an  analysis  of  hazard  in  each  state  has  been  made, 


no  PRINCIPLES  OF  INSURANCE 

an  addition  called  the  conflagration  addition  or  charge 
might  be  made  in  the  interest  of  all.  If  a  particular  state 
levies  heavy  taxes  and  other  charges  upon  insurance,  this 
should  also  be  added  to  the  normal  charge  for  the  ana- 
lyzed hazard.  It  may  be  inquired  further  if  such  state 
classification  is  permitted  in  determining  the  rate,  is  it 
not  logical  to  apply  it  to  the  minor  political  divisions  in 
the  state  in  order  that  the  property  holders  in  one 
county,  city,  or  town  may  not  be  compelled  to  bear  the 
losses  of  those  in  other  similar  political  divisions.  If, 
as  will  be  shown  later,  there  has  been  a  really  scientific 
analysis  of  the  hazard  incident  to  each  risk,  a  result  ap- 
proaching this  is  in  fact  accomplished.  That  is,  bad 
risks,  poor  protection,  and  other  contributing  factors 
to  the  fire  loss  in  one  community  may  be  and  are  very 
properly  penalized  by  a  higher  charge. 

The  Limits  and  Value  of  Classification.  —  Classifi- 
cation properly  understood  and  properly  limited  has  its 
value  in  fire  insurance,  but  not  primarily  in  determining 
the  exact  rate  for  a  particular  risk.  The  insurance  com- 
panies have  been  accustomed  to  keep  the  classified 
records  of  their  experience.  Such  records  enable  the 
company  to  know  how  much  of  their  insurance  is  on  one 
or  the  other  classes  of  property,  how  much  is  received  in 
premiums,  and  how  much  is  paid  in  losses  on  each  class 
of  property  and  in  each  political  division.  They  know 
whether  dwelling  houses,  for  example,  are  profitable  or 
are  insured  at  a  loss.  Such  classification  is  also  of  some 
value  in  determining  the  adequacy  of  the  charges  in  the 
system  of  schedule  rating  in  respect  to  the  base  rate. 
It  is  also  a  measure  or  test  of  the  correctness  of  the 


RATES  AND  RATING  in 

schedule  when  it  is  applied.  The  first  test  of  a  schedule 
is  to  determine  whether  it  has  produced  sufficient  pre- 
miums to  pay  the  losses  on  the  business  as  a  whole.  In 
the  past  each  company  has  considered  its  classified  ex- 
perience a  trade  secret,  but  under  the  present  plans 
there  is  provision  for  the  filing  of  the  experience  of  many 
companies,  and  when  the  results  are  classified  and  made 
known,  a  valuable  body  of  data  will  be  available.  It 
will  probably  not  make  the  question  of  determining  a 
particular  rate  on  a  particular  building  any  more  simple 
than  it  now  is,  but  it  will  give  sure  information  as  to  the 
adequacy  of  rates  on  large  groups  of  property  and  in  dif- 
ferent sections  of  the  country.  The  only  classification 
which  is  of  final  importance  in  arriving  at  rates  is  a 
classification  based  upon  hazard  and  not  upon  kinds  of 
property  or  the  uses  to  which  it  is  placed,  however  im- 
portant for  general  information  the  results  of  classified 
experience  may  be. 

In  1914  the  National  Board  of  Fire  Underwriters 
adopted  a  plan  for  reporting  losses  on  the  basis  of  occu- 
pancy hazards  and  provided  an  Actuarial  Bureau  to 
gather  and  prepare  such  information.  The  experience 
of  the  companies  reporting  is  combined  and  tabulated 
"  for  the  purpose  of  obtaining  the  fire  loss  cost  of  each 
and  every  class  of  hazard  in  the  United  States."  One 
hundred  and  eighty-four  companies  are  reporting  to  this 
Bureau,  and  in  time  there  will  be  available  more  reliable 
statistics  of  fire  losses,  but  such  a  compilation  of  pre- 
miums by  classes  will  have  no  value  for  specific  rate- 
making  purposes.  It  will  show  whether  a  company  has 
made  or  lost  money  on  a  particular  class  in  a  particular 


112 


PRINCIPLES  OF  INSURANCE 


state  and  whether  it  is  doing  a  profitable  business  as  a 
whole  in  a  particular  state.  Yet  this  fact  if  favorable 
to  the  company  cannot  be  used  either  by  the  state  regu- 
lating officials  or  by  other  companies  as  a  rule  in  estab- 
lishing specific  rates.  A  company  might  with  a  given 
rate  have  a  favorable  experience  in  one  state  on  a  certain 
class  of  property  and  an  unfavorable  experience  in 
another  state  on  the  same  class  under  the  same  rate.  A 
single  state's  experience  is  not  a  sufficient  guide  for 
making  rates  on  that  class  of  property. 

The  following  table  shows  the  total  average  cost  per 
$100  of  insurance  written  during  a  ten-year  period  end- 
ing with  1914,  with  5  per  cent  added  for  profit. 


TOTAL  COST  PER 
$100  INSURANCE 
INCLUDING  CON- 
FLAGRATION COST 
AND  s  %  PROFIT 


AVERAGE  RATE 

PAID  TO  ALL 

COMPANIES 


Maine 1-538 

New  Hampshire 1.169 

Vermont 1.301 

Massachusetts 1-035 

Rhode  Island .853 

Connecticut .841 

New  York .751 

New  Jersey .864 

Pennsylvania i.oio 

Delaware .730 

Maryland i.ooo 

District  of  Columbia .535 

West  Virginia        1-544 

Virginia        1.405 

North  Carolina 1.281 

South  Carolina i-37o 


i-47 
1.27 

1.38 
.98 
.96 

1.  00 

•74 
.89 
.98 
•74 
•95 
•53 
1.46 


1.19 

1.30 


RATES  AND   RATING 


TOTAL  COST  PER 
$100  INSURANCE 
INCLUDING  CON- 
FLAGRATION COST 
AND  5  %  PROFIT 


AVERAGE  RATE 

PAID  TO  ALL 

COMPANIES 


Georgia .     .  1.355 

Florida 2.174 

Alabama 1.888 

Mississippi 1-974 

Louisiana 1-447 

Ohio        1.063 

Indiana   .    . • .    .    .  1.079 

Michigan 1-197 

Wisconsin 1.258 

Minnesota 1-436 

Kentucky 1.410 

Tennessee 1.624 

Illinois 1-259 

North  Dakota 2.019 

South  Dakota i-47* 

Iowa 1-430 

Nebraska 1-223 

Missouri       1.123 

Kansas z-359 

Oklahoma 1-392 

Arkansas 1.822 

Washington i-7*7 

Oregon -    .     .     .  1.666 

Idaho 2.251 

Montana 1-937 

Wyoming 1-532 

California 1-463 

Nevada 2.106 

Utah        1-103 

Colorado 1.366 

Arizona         2.168 

New  Mexico 1-740 

Texas 1.601 

United  States 1.125 


i-43 
2.06 
1-65 
2-05 
i-37 

1.  00 

•99 
1.05 

1.  10 

1.23 
1-23 
1-38 


1.67 
1.40 
1.07 
1.04 

I.OO 
1.  12 
1-23 
1.49 


1-38 

i-73 
2.07 

i-73 
i-37 
2.19 

i-i3 
1-39 
2.17 

1-59 
1-30 
i.  06 


ii4  PRINCIPLES  OF  INSURANCE 

Early  System  of  Rating.  —  If  classification  on  the 
basis  of  occupancy,  that  is,  on  the  kind  of  business  which 
is  transacted  in  the  building,  does  not  afford  a  proper 
means  of  determining  the  rate,  what  method  can  be  used  ? 
For  many  years  rates  were  made  by  the  fire  insurance 
officials  and  underwriters  on  the  basis  of  brick  and 
frame  buildings.  A  rate  was  made  for  each  without 
much  regard  to  the  hazards  other  than  this  construction 
hazard.  As  the  business  developed,  each  company  kept 
its  experience  on  classes  of  buildings,  and  increased  or 
decreased  rates  according  to  this  experience  or  as  condi- 
tions of  competition  compelled  them  to  do  so.  The  field 
men,  the  local  agents,  and  general  agents  from  their  ex- 
perience and  observation  agreed  upon  such  rates  as  in 
their  opinion  expressed  the  hazard  of  the  properties  to 
be  insured.  It  was  a  system  of  purely  judgment-made 
rates  with  little  attempt  to  analyze  the  different  haz- 
ards of  each  risk.  Discrimination  both  in  respect  to 
different  kinds  of  property  and  as  to  persons  was  fre- 
quently present.  This  resulted  partly  because  of  the 
system  of  rate -making  and  partly  because  of  the  exces- 
sive competition  which  this  method  of  making  rates 
invited.  There  was  no -standard  by  which  to  measure 
hazard,  and  if  one  company's  experience  was  more  fa- 
vorable than  another's,  it  might  for  this  or  for  any  one  of 
many  other  reasons  decide  to  cut  rates  to  secure  addi- 
tional business.  Each  company  considered  its  experience 
a  trade  secret.  Rate  wars  were  common,  and  as  is 
always  the  case  in  such  contests,  the  price  paid  adjusted 
itself  to  the  strength  of  the  buyer  and  not  according 
to  the  hazard  of  his  property.  When  peace  was  restored 


RATES  AND  RATING  115 

the  companies  sought  to  increase  their  rates,  with  the 
result  that  the  public  objected.  The  companies  sought 
to  make  agreements  for  the  purpose  of  observing  rates 
and  commissions,  but  this  the  public  interpreted  as 
monopoly  conduct,  and  forbade  it  by  legal  enactment. 
It  is  not  suggested  that  these  evils  did  not  persist  to  some 
extent  after  an  improved  system  of  rate-making  was  de- 
vised, but  the  inducement  to  such  action  was  much 
greater  under  the  old  system  of  making  rates  according 
to  judgment  and  the  experience  of  each  company. 

Schedule  Rating.  —  The  present  system  of  rate-making 
is  called  schedule  rating,  and  is  increasingly  used  in  de- 
termining the  rates  on  all  kinds  of  property.  The  theory 
underlying  the  system  of  schedule  rating  is  that  the 
hazard  of  each  risk  can  be  analyzed  into  its  component 
parts  and  that  the  rate  may  be  derived  for  each  risk  by 
a  system  of  charges  and  credits,  added  to  or  subtracted 
from  a  base  rate  which  expresses  the  unanalyzable  parts 
of  the  hazard.  It  will  at  once  be  recognized  that  this 
system  of  schedule  rating  does  not  exclude  judgment  as 
compared  with  the  earlier  system,  since  the  base  rate 
itself  as  well  as  specific  charges  and  credits  is  a  result 
of  judgment.  The  difference  is  that  the  judgment  used 
in  schedule  rating  is  based  upon  a  large  accumulation  of 
specific  facts. 

The  Universal  Mercantile  Schedule.  —  There  are  a 
number  of  systems  of  schedule  rating,  but  the  two 
most  important  are  the  Universal  Mercantile  and  the 
Analytical  System.  These  apply  to  mercantile  and 
the  common  manufacturing  properties  alone,  and  only  to 
those  which  are  not  equipped  with  automatic  sprinkler 


n6  PRINCIPLES  OF  INSURANCE 

systems.  The  Universal  Mercantile  Schedule  was  pre- 
pared by  a  committee  of  which  Mr.  F.  C.  Moore  was 
chairman.  This  system  has  been  modified  and  adapted 
in  many  respects,  and  in  its  various  changed  forms,  is  in 
very  general  use  in  the  eastern  section  of  the  United 
States.  These  schedules  are  very  complicated,  and  only 
the  general  outlines  of  the  systems  are  given. 

The  Universal  Mercantile  System  is  based  upon  a 
standard  building  in  a  standard  city  which  has  what  is 
called  a  key  rate.  The  standard  city  is  one  with  water- 
works of  a  certain  standard  of  efficiency,  with  water  mains 
of  not  less  than  eight  inches  in  diameter  in  the  business 
district  and  not  less  than  six  inches  in  diameter  in  the 
residence  district.  The  fire  department  has  also  a  stand- 
ard applied  to  it,  as  well  as  the  paving  of  the  streets  and 
their  width.  In  addition,  there  must  be  an  efficient 
police  force.  The  city  must  have  a  good  building  code 
and  a  fire  loss  record  for  five  years  not  to  exceed  five 
dollars  per  year  per  $1000  of  insurance.  Likewise  a 
standard  building  was  assumed.  Among  other  require- 
ments the  building  must  not  have  over  two  thousand 
five  hundred  square  feet  of  area,  the  walls  must  be  of  a 
certain  thickness,  the  building  must  not  be  over  four 
stories  high  and  of  approved  construction.  Other  re- 
quirements were  established  for  this  standard  building 
and  the  standard  city  with  the  purpose  of  securing  a 
measuring  unit  for  actual  buildings  in  actual  cities. 
For  this  standard  building  in  this  standard  city  a 
rate  of  twenty-five  cents  per  $100  of  insurance  was 
established. 

This  was  known  as  the  basis  rate  and  represented  a 


RATES  AND   RATING  117 

sum  from  which  or  to  which  subtractions  or  additions 
were  made  for  any  features,  superior  or  inferior  to  these 
established  standards  in  the  actual  building  to  be  rated. 
In  arriving  at  the  actual  rate  for  a  building  in  a  given 
city,  allowance  was  first  made  for  the  degree  to  which 
the  particular  city  exceeded  or  fell  short  of  the  standard 
city.  This  gave  the  key  rate  for  a  standard  building  in 
a  given  city.  The  next  step  is  to  make  deductions  or 
allowances  for  an  actual  building  in  the  given  city,  since 
each  building  to  be  rated  would  differ  from  this  standard 
building.  After  these  calculations  had  been  made,  the 
rate  arrived  at  by  these  additions  and  subtractions  would 
be  the  one  for  the  actual  building  unoccupied  in  the 
actual  city.  Then  to  this  rate  there  was  added  the 
charge  for  occupancy,  and  to  this  the  rate  for  the  occupied 
building,  exposed.  Other  additions  were  made  or  al- 
lowed in  the  rate  if  the  coinsurance  clause  was  present 
or  absent  in  the  policy,  and  for  such  items  as  taxation, 
or  improper  or  careless  use  of  the  property.  Thus  the 
final  rate  would  be  secured  by  a  process  of  measuring 
good  and  bad  features  in  the  risk  as  compared  with  the 
standard  building  in  the  standard  city,  with  additions 
for  occupancy  and  other  features  of  the  risk.  Many 
modifications  of  this  Universal  System  have  been  made 
to  adapt  it  to  different  kinds  of  property  and  to  different 
sections  of  the  territory  to  which  it  is  applied. 

The  Analytical  System.  —  Another  system  of  schedule 
rating  which  is  of  general  importance  is  the  Analytical 
System.  This  was  invented  by  Mr.  A.  F.  Dean.  This 
system  does  not  assume  a  standard  building  in  a  standard 
city,  but  divides  cities  into  six  classes,  based  upon  their 


n8  PRINCIPLES  OF  INSURANCE 

protection  against  fire.  The  starting  point  in  the  system 
is  a  one-story  brick  building  in  a  town  of  the  sixth  class. 
This  building  is  not  an  ideal  one,  but  is  a  standard  type 
of  building  of  ordinary  construction  such  as  is  found  in 
an  actual  town.  For  this  one-story  building  the  Analyti- 
cal System  has  a  number  of  tables  which  give  a  basis  rate 
for  each  of  the  classes  of  cities.  There  is  no  attempt 
made  to  select  one  specific  base  rate  for  all  cities.  There 
are  tables  beginning  with  the  60  cent  rate  for  this  one- 
story  brick  building  in  a  town  of  the  sixth  class,  and 
other  tables  up  to  120  cents.  It  is  assumed  that  the 
underwriter  or  whoever  makes  the  rates  for  the  state 
will  know  best  which  one  of  these  tables,  running  from 
60  to  1 20  cents,  most  nearly  represents  his  state.  But 
when  once  the  particular  table  is  selected,  it  should  be 
adhered  to  in  rating  all  the  risks  in  the  state.  All  cities 
and  towns  in  the  same  state  generally  take  the  same 
basis  table,  which  contains  base  rates  for  all  classes  of 
cities.  For  example,  the  60  cent  table  has  this  rate 
for  a  sixth  class  city,  a  57  cent  rate  for  a  fifth  class,  42 
cents  for  a  third  class,  and  33  cents  for  a  first  class  city. 
Likewise  the  120  cent  table  takes  this  rate  for  the  one- 
story  brick  building  in  the  sixth  class  city,  and  corre- 
spondingly lower  rates  for  the  better  class  of  cities. 
Whichever  table  is  selected  in  accordance  with  the  local 
conditions,  the  base  rate  or  starting  point  in  building  up 
the  rate  is  found  in  the  table.  To  this  base  rate,  addi- 
tions and  subtractions  are  made  for  good  and  bad 
features  in  the  occupancy,  the  construction,  the  pro- 
tection, and  the  exposure.  This  schedule  has  a  very 
minute  analysis  of  occupancy  and  exposure. 


RATES  AND   RATING  119 

Comparison  of  the  Universal  and  Analytical  Systems.— 
The  chief  differences  in  these  two  important  schedule 
rating  systems  are  as  follows.  First,  since  the  Dean 
Schedule  starts  with  an  average  building  in  an  actual  city, 
the  charges  and  credits  will  be  less ;  that  is,  the  adjust- 
ments will  be  fewer  than  in  the  Universal  Schedule, 
which  starts  with  an  ideal  building  in  an  ideal  city. 
Second,  the  additions  and  subtractions  in  the  Dean 
Schedule  are  based  upon  percentages  of  the  base  rate, 
whereas  in  the  other  system  it  is  a  flat  charge.  The  per- 
centage method  emphasizes  the  relativity  of  the  credit 
or  debit.  An  addition  of  10  cents  for  a  bad  feature  in 
a  risk  is  quite  different  from  an  addition  of  10  per  cent 
for  the  same  feature.  In  the  latter  case  it  is  10  per  cent 
of  the  base  rate.  Suppose  the  base  rate  in  each  case  is 
40  cents.  In  one  case  the  bad  feature  is  responsible 
for  an  addition  of  10  cents,  while  in  the  other  case  4  cents 
is  assumed  to  represent  its  added  hazard.  Third,  /the 
Analytical  System  is  more  elastic  than  the  Universal 
System.  The  systems  differ  in  other  respects,  but  in 
most  cases  they  are  too  complicated  for  detailed  descrip- 
tion. The  important  fact  is  to  realize  that  in  each  sched- 
ule the  purpose  is  to  analyze  the  constituent  elements 
in  the  hazard.  Neither  schedule  assumes  that  the 
actual  facts  prove  that  the  specific  addition  made  ex- 
presses the  exact  hazard.  Our  present  knowledge,  and  in 
all  probability  our  future  knowledge,  will  not  tell  us  that 
20  cents,  for  example,  should  be  added  for  the  absence 
or  presence  of  some  feature  as,  for  instance,  a  shingle  roof. 
The  most  complete  statistics  of  fire  losses  will  not  dis- 
close how  much  a  rubber  hose  gas  connection  adds  to 


120  PRINCIPLES  OF  INSURANCE 

the  hazard  of  a  risk.  There  are  hundreds  of  such  items 
connected  with  a  risk  which  are  of  this  character.  A 
schedule  is  made  up  by  comparison,  by  judgment,  and 
by  the  result  of  experience.  Such  a  schedule  is  not  an 
exact  measure  of  the  individual  items  in  the  hazard,  but 
such  a  system  has  the  merit  of  consistency  and  relative 
fairness.  This  is  more  than  can  be  claimed  for  the  earlier 
method.  Above  all,  schedule  rating  affords  a  powerful 
inducement  to  property  owners  and  to  communities  to 
make  such  improvements  as  will  reduce  the  fire  loss.  A 
waterworks  system  with  inadequate  pressure,  a  city 
with  a  poor  building  code,  an  individual  property  without 
a  fire  alarm  system  in  each  case  is  a  contributing  factor 
to  a  loss  by  fire.  Under  a  system  of  schedule  rating  the 
community  and  the  individual  know  that  so  much 
of  an  allowance  is  permitted  when  they  remove  the 
objectionable  features.  Schedule  rating,  although  em- 
pirical, is  the  best  known  method  of  apportioning  the 
fire  cost. 

The  Experience  Grading  and  Rating  Schedule.  — 
A  schedule  based  upon  the  combined  experience  averages 
of  companies  has  been  proposed  by  Mr.  E.  G.  Richards. 
Neither  the  Mercantile  nor  Dean  Schedule  is  based  upon 
the  actual  tabulated  experience,  since  such  experience 
has  never  been  completely  analyzed  and  made  available 
except  as  losses  in  the  country  as  a  whole,  in  states,  or 
in  other  political  divisions.  As  has  been  described,  these 
two  schedules  are  based  upon  the  plan  of  assessing  spe- 
cific charges  for  particular  features  of  the  hazard.  These 
charges  are  in  general  of  an  arbitrary  character.  Yet 
the  idea  that  actual  experience  on  different  classes  of 


RATES  AND   RATING  121 

property  and  in  different  regions  affords  the  true  basis 
for  rate-making  has  persisted  and  has  been  urged  by  the 
public,  by  state  regulatory  officials,  and  by  some  insur- 
ance officials.  There  is  no  doubt  a  tendency  on  the  part 
of  the  states  to  insist  that  the  experience  of  companies  be 
classified  and  that  the  results  of  this  experience  receive 
more  consideration  in  determining  the  rates  for  insur- 
ance in  the  particular  states. 

The  schedule  published  by  Mr.  Richards  in  1915  is 
called  "  The  Experience  Grading  and  Rating  Schedule," 
and  represents  a  very  completely  organized  system  for 
using  experience  as  the  basis  of  rate  determination. 

The  National  Board  of  Fire  Underwriters  has  under- 
taken through  its  Actuarial  Bureau  the  task  of  combining 
the  experience  of  the  companies  which  are  members  of 
this  board,  and  this  schedule  proposes  to  use  these  data  as 
the  basis  for  determining  rates.  The  Experience  Grad- 
ing and  Rating  Schedule  proposes : 

First,  to  analyze  the  hazard  by  its  comparative  quali- 
ties in  place  of  the  present  method  of  analyzing  its  spe- 
cific parts  and  uses. 

Second,  to  determine  "  the  average  rate  which  stock 
fire  insurance  companies  should  have  fairly  received 
throughout  the  United  States  upon  all  risks  of  every  class 
over  a  period  sufficient  for  an  average,  say  ten  years." 
This  is  the  basis  or  starting  point  of  this  new  schedule. 
This  average  would  be  obtained  by  compiling  the  losses 
and  expenses  and  adding  to  this  a  fair  profit  on  the 
capital  invested.  This  result  divided  by  the  total 
amount  insured  would  give  this  average  rate. 

Third,  to  calculate  in  a  similar  manner  the  average 


122  PRINCIPLES  OF  INSURANCE 

rate  for  each  state,  charging  to  each  state  such  items  as 
taxes  and  license  and  any  other  specific  parts  of  the  ex- 
pense which  are  incurred  in  that  state  and  pro-rating 
among  the  states  the  unanalyzable  remainder  of  the  ex- 
penses. It  is  assumed  that  the  conflagration  expenses 
will  be  distributed  among  all  the  states.  Having  now 
determined  the  average  rate  for  the  average  risk  in  the 
United  States  and  the  average  rate  for  the  average  risk 
in  each  state,  the  next  step  is : 

Fourth,  to  determine  the  rate  for  an  average  risk  in  a 
specific  class  in  the  United  States.  This  in  the  proposed 
plan  would  be  done  by  classifying  the  towns  and  cities 
of  the  United  States  into  ten  groups :  by  classifying  the 
occupancy,  including  private  protection,  building  con- 
struction and  exposure,  internal  and  external.  Having 
all  this  experience  reported  and  tabulated,  the  analysis 
of  it  would  give  the  rate  on  an  average  risk  in  its  particu- 
lar class,  grade,  and  location  and  likewise  the  rate  on  such 
a  risk  in  each  state.  The  author  of  this  schedule  bases  it 
upon  his  belief  that  "  the  desideratum  of  schedule  rating 
will  be  found  in  the  direction  thus  indicated,  for  with 
hazards  limited  to  such  as  are  fundamental  and  each  haz- 
ard subdivided  into  its  comparative  parts  from  best  to 
poorest,  a  rating  schedule  can  be  formulated,  each  part  or 
unit  of  which  will  be  the  clear  and  demonstrable  outcome 
of  underwriting  experience  and  cost." 

It  will  be  understood  that  the  proposed  plan  is  de- 
pendent upon  a  uniform  classification  of  experience  of  all 
companies  and  would  require  a  survey  and  grading  of 
every  risk.  The  strong  feature  of  the  proposed  plan  is 
the  consideration  which  it  seeks  to  give  to  the  actual 


RATES  AND   RATING  123 

experience  of  companies  in  insuring  property.  But  it, 
like  the  systems  now  in  use,  would  have  a  large  element 
of  arbitrariness  in  it.  This  arbitrary  element  will  always 
be  found  in  any  rating  system  of  insurance,  just  as  it  is 
found  in  railway  rates  or  in  any  other  price  which  has  so 
many  complex  factors  entering  into  its  determination. 
No  magic  yardstick  can  be  applied.  No  cost  system  of 
the  most  complete  character  will  make  possible  the  spe- 
cific identification  and  distribution  of  every  element  in 
the  cost. 

The  point  at  which  the  theoretical  justification  for 
classification  is  found  is  infinity.  Nevertheless,  the 
system  proposed  by  Mr.  Richards  has  within  it  many 
of  the  best  features  of  the  plans  now  in  use,  and  in  addi- 
tion gives  more  consideration  to  actual  experience  in 
larger  groups.  It  may  be  that  the  new  system  over- 
emphasizes the  average  risk  just  as  the  present  system 
stresses  too  much  the  individual  risk.  As  has  been  stated 
there  are  a  number  of  other  schedules,  but  they  are  either 
of  minor  application  or  are  like  the  above  system,  pro- 
posals which  have  not  been  actually  applied. 

The  L.  and  L.  Schedule.  —  Another  schedule  which 
is  receiving  attention  is  the  L.  and  L.  Rating  System. 
This  schedule  was  devised  in  1915  and  has  had  some 
experimental  application.  Among  other  features  of  this 
system  the  following  are  important : 

First,  The  basis  rate  and  charges  are  graduated  accord- 
ing to  fire  protection  available. 

Second,  Rates  are  to  be  so  adjusted  as  to  provide  aver- 
age loss  ratios  of  50  per  cent  of  the  premiums  excluding 
conflagration. 


124  PRINCIPLES  OF  INSURANCE 

Third,  Towns  are  graded  into  ten  classes. 

Fourth,  There  are  three  schedules :  non-fireproof  brick, 
fireproof,  and  frame  and  miscellaneous. 

Fifth,  The  "  Burning  Degree  "  as  determined  by  the 
ignitibility  of  the  risk  supplies  the  basis  for  a  high  degree 
of  analysis. 

Sixth,  Rates  are  based  upon  an  80  per  cent  coinsurance 
clause. 

Like  the  other  schedules,  the  L.  and  L.  Schedule  pro- 
vides for  a  high  degree  of  analysis  with  specific  charges 
and  allowances.  In  the  occupancy  list  there  are  1252 
classes. 

How  Rates  are  Made.  —  Rates  are  made  either  by 
the  companies  or  by  independent  organizations.  When 
they  are  made  by  the  companies,  this  is  done :  (a)  by 
the  company  officers  or  surveyors,  as  in  the  case  of  the 
Factory  Mutual  Insurance  Associations;  (b)  by  field 
men  of  the  company  or  by  surveyors  under  their  direc- 
tion, as  in  the  territory  of  the  New  England  Insurance 
Exchange ;  (c)  by  local  agents,  or  surveyors  under  the 
supervision  of  the  company.  The  independent  rating 
is  done  by  organizations  called  rating  bureaus  or  in- 
spection bureaus,  which  are  numerous  throughout  the 
Middle  West.  These  bureaus  employ  inspectors,  sur- 
veyors, and  other  technical  experts  who  examine  a  build- 
ing or  a  city  and  determine  the  rate  to  be  charged.  This 
information  or  service  is  sold  to  the  insurance  companies. 
These  rating  bureaus  are  in  fact  a  result  of  the  laws  that 
were  passed  in  a  number  of  states,  which  prohibited  the 
companies  from  forming  associations  to  derive  rates  and 
to  agree  upon  their  observance. 


RATES  AND   RATING  125 

Competition  in  Determining  Rates.  —  It  will  be  ob- 
served that  so  far  as  there  is  success  in  analyzing  the 
constituent  hazard  of  a  risk  or  class  of  risks  there  is  no 
reason  for  variation  in  the  price  which  should  be  charged, 
in  so  far  as  it  is  determined  by  the  fire  loss  alone.  The 
fire  loss  must  be  distributed,  and  the  basis  of  its  distri- 
bution should  be  the  relative  hazard  or  probable  contri- 
bution which  each  property  is  to  make  to  this  loss. 
There  is  no  place  for  competition  among  companies  in 
determining  the  burning  rate.  Nothing  that  any  one 
company  can  do  will  affect  this  part  of  the  charge  for 
insurance.  One  company  may  be  more  economical 
than  another  in  administering  its  business ;  it  may  be 
more  successful  in  securing  good  returns  from  its  invest- 
ments ;  it  may  secure  better  service  from  its  agents ;  but 
the  burning  rate  is  not  determined  by  the  company's 
conduct.  There  can  be  competition  in  the  service  to  be 
rendered  by  insurance  companies,  but  the  public  should 
not  encourage  them  to  compete  in  the  making  of  the  rate. 
This  has  been  frequently  required  by  state  laws.  The 
companies  have  been  prevented  in  some  states  from 
cooperating  in  making  rates.  If  this  cooperation  in 
rate-making  is  done  under  the  supervision  of  the  state, 
nothing  but  public  good  need  result.  A  period  of  rate- 
cutting  among  companies  has  usually  meant  one  of  two 
things.  Either  the  public  did  not  get  good  insurance, 
that  is,  the  company  often  failed  as  a  result  of  the  ex- 
tremely unprofitable  rate  at  which  it  secured  the  busi- 
ness, or  —  and  this  is  the  more  usual  result  —  the  de- 
ficiency in  charge  to  one  group  of  policyholders  was 
made  up  on  another,  that  is,  discrimination  resulted  from 


i26  PRINCIPLES  OF  INSURANCE 

excessive  competition.  Then  again,  a  rate  war,  no  more 
than  any  other  kind  of  a  war,  could  continue  indefinitely. 
When  peace  came,  rates  were  sought  to  be  advanced, 
and  this  engendered  additional  public  opposition.  If  the 
public  would  understand  that  the  price  of  fire  indemnity 
is  very  largely  determined  for  the  insurance  companies 
by  conditions  and  forces  over  which  they  have  little 
control,  the  question  of  public  regulation  of  fire  insurance 
would  be  much  simplified. 

Public  and  Private  Rate-making.  —  The  question  of 
public  or  private  rate-making  has  been  receiving  during 
the  last  decade  increased  attention.  A  number  of  in- 
vestigations of  the  fire  insurance  business  have  been  made 
with  the  view  of  examining  three  accusations  which  have 
been  frequently  made  against  fire  insurance  companies. 
First,  were  fire  insurance  companies  guilty  of  monopolis- 
tic practices  of  a  character  similar  to  that  of  the  trusts  ? 
Second,  were  such  companies  guilty  of  discriminating 
in  rates?  Third,  was  the  expense  of  such  companies 
unduly  high?  It  cannot  be  said  that  these  numerous 
investigations  have  satisfactorily  answered  these  ques- 
tions for  many  people.  The  first  question  arose  from 
practices  already  described  in  regard  to  making  rates. 
No  one  denied  that  there  were  many  different  companies 
of  independent  ownership.  But  because  the  greater 
number  of  the  companies  charged  the  same  rate  for  in- 
suring a  building,  it  appeared  to  many  purchasers  of  in- 
surance that  there  must  be  some  kind  of  a  covert  under- 
standing among  companies  as  to  prices.  The  ordinary 
purchaser,  accustomed  to  "  higgling  "  over  prices,  could 
not  understand  why  the  "  one-price-to-all  "  principle  of 


RATES  AND   RATING  127 

insurance  companies  did  not  prove  the  existence  of  a 
monopoly.  To  the  extent  that  the  fire  hazard  is  accu- 
rately measured,  to  that  extent  there  should  be  uniform- 
ity of  rates ;  and  the  similarity  in  price  does  not  prove 
a  combination  against  the  public,  but  rather  a  measure 
of  a  charge  that  the  public  inflicts  upon  itself.  A  com- 
bination and  agreement  among  companies  to  make  rates 
is  one  thing,  and  a  combination  to  maintain  such  rates 
in  opposition  to  improvements  is  another  thing.  The 
first  should  be  encouraged  and  required  by  law,  because 
this  would  work  to  produce  an  economy  in  the  expense. 

If  it  is  admitted  that  the  fire  hazard  is  measurable  — 
and  to  deny  it  is  to  adopt  a  method  of  guessing  which 
would  preclude  any  justice  in  the  charge  and  also  to 
neglect  a  large  body  of  accumulated  experience,  which 
proves  the  contrary  —  then  this  measurable  quantity  — 
the  hazard  —  does  not  need  to  have  different  individuals 
to  do  the  measuring.  It  would  almost  be  like  asking  ten 
persons  to  measure  a  distance  of  a  mile  with  a  yardstick. 
There  might  be  a  slight  difference  in  inches  in  the  result, 
but  these  would  not  be  of  any  great  significance.  If  one 
competent  person  does  the  measuring,  his  results  may 
profitably  be  accepted  by  all. 

Doubtless  some  of  the  opposition  to  the  companies  for 
their  assumed  monopolistic  action  has  arisen  from  the 
fact  that  in  many  cases  they  were  foreign  companies,  that 
is,  either  of  other  states  or  of  foreign  countries.  In  many 
cases  the  evils  of  an  absentee  landlord  seem  to  exist. 
There  was  no  one  except  the  agent  who  personally  repre- 
sented them,  and  as  has  been  shown,  the  fire  insurance 
agent  while  legally  the  representative  of  the  company, 


128  PRINCIPLES  OF  INSURANCE 

is  in  the  practical  conduct  of  the  business  quite  as 
frequently  the  representative  of  the  policyholder.  He 
represents  many  companies,  and  is  anxious  to  please 
the  policyholder  and  the  public  who  supply  him  with 
business.  Indeed,  in  those  cases  where  rating  bureaus 
or  other  rating  organizations  independent  of  the  com- 
panies have  come  into  existence,  the  companies  are  com- 
ing more  and  more  to  rely  upon  them  than  upon  the 
agent  to  protect  their  interest,  so  far  as  securing  an  ade- 
quate price  or  rate  for  the  insurance.  Not  infrequently 
the  agent  in  fire  insurance  solicits  the  rating  organization 
for  a  favorable  rate  just  as  the  life  insurance  agent  some- 
times is  anxious  for  the  medical  examiner  to  make  a  fa- 
vorable report  on  a  life  which  he  proposes  for  insurance. 
Uniformity  in  Rates.  —  In  general  it  may  be  said  that 
there  can  be  little  doubt  as  to  the  final  result  of  the  dis- 
cussion about  competition  and  agreement  as  to  the  fire 
insurance  rate,  so  far  as  it  is  made  up  of  the  fire  hazard. 
As  the  nature  of  fire  insurance  becomes  better  understood, 
the  uniformity  in  rates  will  become  more  marked  whether 
it  be  under  a  system  of  private  or  public  insurance.  There 
will  never  be  a  settlement  of  the  rate  problem.  Condi- 
tions change  so  rapidly  in  respect  to  the  numerous  haz- 
ards that  adjustments  will  be  made  continually,  and  there- 
fore the  extent  and  character  of  the  adjustments  will  al- 
ways be  a  subject  for  discussion  and  difference  of  opinion. 
But  however  much  discussion  there  may  be  as  to  details 
of  the  rate  there  can  be  none  as  to  the  method  of  making 
rates.  They  should  be  made  by  one  body.  That  is, 
by  the  companies,  associated  or  by  an  independent  body 
which  sells  this  service  to  companies  which  should  be 


RATES  AND   RATING  129 

forced  to  use  them  or  by  the  state  itself  or  under  its  super- 
vision. 

Discrimination  in  Fire  Insurance.  —  The  second  ac- 
cusation which  has  frequently  been  made  against  the 
companies  is  that  they  have  been  guilty  of  discrimina- 
tion. On  this  count,  the  fire  insurance  companies  have 
not  been  able  to  make  such  a  clear  case  of  innocence. 
Discrimination  in  fire  insurance  rates  may  be  of  three 
kinds :  between  persons,  that  is,  individual  property  of 
the  same  kind,  between  classes  of  property,  and  between 
places  or  political  divisions  such  as  cities  or  states. 
There  have  undoubtedly  been  numerous  examples  of  all 
these  classes  of  discriminations.  Some  discrimination 
yet  exists,  especially  in  the  case  of  classes  of  property. 

Personal  Discrimination.  —  The  first  kind  of  discrimi- 
nation, that  between  persons,  is  almost  wholly  a  result 
of  competition.  The  desire  of  a  company  to  secure  the 
risk,  and  the  skill  of  the  insured  in  playing  off  one  com- 
pany against  another,  results  in  the  insured  securing  a 
lower  rate  than  that  upon  other  property  of  a  like  hazard. 
This  is  especially  prevalent  where  there  is  not  close 
public  supervision  of  the  companies'  operation,  but  even 
with  the  best  devised  form  of  regulation  a  certain  amount 
of  this  kind  of  discrimination  will  persist.  The  large 
buyer  under  our  present  economic  system  has  an  advan- 
tage over  the  smaller  buyer  which  it  is  difficult  to  control. 

Property  Discrimination.  —  The  second  class  of  dis- 
crimination, that  between  classes  of  property,  is  a  result 
in  part  of  competition,  in  part  of  the  lack  of  complete 
data  as  to  the  hazard  of  different  classes  of  property  and 
the  losses  on  these  different  classes  as  compared  to  the 


i3o  PRINCIPLES  OF  INSURANCE 

premium  receipt,  and  finally,  in  part,  as  an  easy  method 
in  practice,  of  adjusting  means  to  an  end.  So  far  as  com- 
petition has  affected  this  kind  of  discrimination,  it  has 
resulted  from  the  fact  that  on  certain  classes  of  property 
there  is  greater  competition  for  the  business  than  on 
others.  The  result  has  been  that  the  rate  was  made 
something  below  the  real  hazard  or  at  least  less  than 
what  would  bring  a  profitable  return.  The  difference  or 
deficit  has  been  made  up  on  other  classes  of  property 
which  could  stand  a  charge  higher  than  the  real  hazard. 
Business  property  usually  represents  considerably  more 
capital  investment  than  dwelling  property.  The  owner 
who  has  a  business  property  valued  at  $100,000  will  bar- 
gain for  an  insurance  rate  as  low  as  possible,  while  on  his 
$10,000  residence  he  is  disposed  to  accept  whatever  rate 
is  quoted  to  him,  since  the  total  out-of-pocket  expense  to 
him  in  the  latter  case  is  much  smaller  than  in  the  former 
case,  however  good  the  bargain  is,  which  he  drives  for  the 
rate  on  his  business  property. 

It  is  also  generally  true  that  there  is  more  competition 
among  companies  for  the  business  property  insurance. 
The  premium  is  larger,  the  expense  of  securing  it  is  often 
favorable,  and  therefore  a  large  net  contribution  may  be 
made  to  the  finances  of  the  company.  The  insurance 
business  is  in  many  respects  subject  to  the  law  of  in- 
creasing return.  Many  of  its  expenses  are  of  such  a  con- 
stant character,  that  a  large  volume  of  business  on  a 
single  risk  brings  a  very  favorable  return. 

Rates  should,  if  they  are  to  be  equitable,  measure  the 
hazard  of  all  classes  of  risks,  but  even  if  this  hazard  is 
known,  competition  must  be  controlled  if  the  insured 


RATES  AND   RATING  131 

is  to  secure  equity  in  the  actual  rate.  In  this  connec- 
tion the  fire  rate  is  similar  to  a  tax.  A  rate  in  taxation 
is  established,  but  whether  the  property  owner  pays  his 
full  tax  depends  upon  his  honesty  in  making  the  return, 
or  the  skill  of  the  taxing  official  in  finding  his  property. 
So  with  the  property  owner  in  paying  his  insurance  charge. 
It  depends  first,  upon  arriving  at  a  rate  which  is  the  true 
measure  of  its  hazard,  and  second,  upon  the  absence  of 
competition  to  see  that  he  pays  all  of  this  rate. 

The  term  "  preferred  classes  "  was  formerly  in  frequent 
use  to  represent  those  classes  of  property  which  brought 
to  the  companies  a  highly  favorable  return.  If,  however, 
rating  ever  becomes  sufficiently  analytical  to  measure  the 
real  hazard  of  all  kinds  of  property,  one  class  of  property 
will  be  as  much  a  preferred  risk  as  another,  provided  there 
is  adequate  control  in  collecting  the  rate.  If  classifica- 
tion has  any  real  service  to  render  to  the  solution  of  the 
problem  of  fire  insurance  rating,  it  is  in  this  connection. 
That  is  to  state,  a  complete  classification  of  the  experi- 
ence of  companies  on  all  classes  of  properties  would  aid 
the  rating  official  in  arriving  at  a  more  equitable  charge. 

Geographical  Discrimination.  —  Classification  may 
also  be  of  some  service  in  the  third  kind  of  discrimination, 
viz.  that  between  states  or  other  smaller  political  divi- 
sions. This  kind  of  discrimination  has  also  in  part  re- 
sulted from  competition.  Not  infrequently  a  rate  war 
has  occurred  in  a  city  or  a  state  and  the  deficit  has  been 
made  up  by  collecting  higher  rates  in  other  sections 
where  the  experience  and  the  hazard  would  entitle 
property  holders  to  a  lower  rate.  Notwithstanding  the 
great  prevalence  of  competition,  naturally  existing  and 


i32  PRINCIPLES  OF  INSURANCE 

legally  enforced  among  companies,  a  condition  of  peace 
among  companies  is  conducive  to  stability  of  rates  in 
the  face  of  facts  justifying  a  reduction.  It  is  easier  for 
an  individual  to  secure  a  reduction  in  rates  than  for  a 
community.  The  past  history  of  companies  affords  so 
many  examples  of  unprofitable  rates  in  so  many  localities, 
that  the  companies  are  loath  to  make,  voluntarily,  a  re- 
duction in  rates  unless  forced  to  do  so.  Interpreted  in 
the  best  light  the  static  rate  seems  to  the  companies  often 
a  collection  of  a  debt  past  due  from  the  insured  public. 
It  again  illustrates  the  similarity  of  the  insurance  charge 
to  a  tax.  One  characteristic  of  a  good  tax  is  its  ease  of 
collection.  Revenue  for  the  state  must  be  collected, 
and  often  the  criterion  of  abstract  individual  or  group 
equity  is  sacrificed  for  the  practical  advantages  of  secur- 
ing the  revenue.  Classification  may  here  be  of  some  serv- 
ice in  that  the  collected  experience  of  the  losses  in  each 
state  may  indicate  the  justice  of  increasing  or  reducing 
the  rates  in  a  particular  state  or  locality.  How  this  in- 
crease or  reduction  is  to  be  distributed  is  a  question  pri- 
marily for  the  rating  official,  since  his  particular  service 
is  to  express  in  the  rate  the  hazard  of  the  particular  risk. 
Nothing  that  is  here  stated  should  be  understood  to  be 
urged  as  a  reason  for  not  assessing  upon  a  particular  state 
its  just  charge  for  the  conflagration  hazard.  No  state 
or  community  should  expect  the  privilege  of  rates  which 
measure  only  their  loss  unless  they  are  willing  to  bear 
that  heavier  charge  which  results  from  large  fires  or  con- 
flagrations. This,  as  has  been  previously  shown,  is  prac- 
tically impossible.  The  fair  and  practical  method  is  to 
give  a  full  application  to  the  principle  that  insurance  is 


RATES  AND  RATING  133 

fundamentally  mutual  and  by  thus  aiding  each  other  at 
times  of  unusual  losses,  the  net  cost  for  all  states  becomes 
over  a  long  period  lower. 

The  Expense  as  a  Cause  of  High  Rates.  —  The  third 
general  accusation  made  against  fire  insurance  companies 
which  has  led  to  these  investigations  is  that  the  expense 
of  such  companies  has  been  unduly  high.  This  subject 
is  deferred  for  a  more  detailed  discussion  to  a  later  chap- 
ter, but  in  this  connection  two  aspects  of  it  may  be  con- 
sidered. The  expense  for  commissions  has  been  the 
center  of  interest  in  the  investigations  and  here  again  the 
companies  and  their  agents  have  not  agreed  in  their 
views.  The  companies  have  attempted  through  various 
organizations  to  standardize  the  commissions,  but  the 
competition  which  the  public  has  encouraged  and  re- 
quired has  often  prevented  the  achievement  of  this  end. 
Many  companies  have  refused  to  join  these  organiza- 
tions and  observe  the  agreement  of  these  "  unions  "  or 
"  boards."  One  of  the  most  effective  means  for  a  com- 
pany to  secure  buisness  is  to  offer  the  agent  a  higher 
commission  for  it.  The  agent  who  represents  several 
companies  is  in  a  position  of  advantage.  The  agent, 
and  especially  the  broker,  can  bargain  with  the  com- 
panies. The  company  was  often  willing  to  pay  the 
agent  a  higher  commission  on  that  class  of  business  which 
its  experience  had  shown  to  be  profitable.  Excessive 
competition  often  expressed  itself  in  fluctuating  commis- 
sions as  well  as  in  fluctuating  rates,  in  discriminating 
commissions  as  well  as  in  discriminating  rates.  The 
public  has  paid  the  price  for  this  competition,  since  the 
public  is  in  final  analysis  the  sole  source  of  revenue  for 


i34  PRINCIPLES  OF  INSURANCE 

the  fire  insurance  charges.  Many  do  not  seem  to  realize 
that  property  owners  pay  for  the  property  loss  by  fire. 
The  rate  paid  is  an  expression  of  this  charge  and,  as  in 
the  taxes,  the  important  question  is  how  to  equitably 
distribute  the  tax  and  the  fire  insurance  rate  among 
persons  and  localities. 

It  was  stated  in  an  earlier  part  of  this  discussion  that 
the  prices  of  a  product  should  bear  its  total  costs  of  pro- 
duction and  that  the  fire  insurance  charge  is  a  part  of  that 
total  cost.  This  cost  can  only  be  assigned  by  an  analysis 
of  the  hazard,  connected  with  the  production  of  the  com- 
modity. Classification  cannot  assign  this  cost.  It  can 
only  aid  in  its  proper  assignment. 

There  remains  one  other  important  question  in  refer- 
ence to  the  determination  and  assignment  of  this  cost, 
viz.  shall  it  be  done  by  the  companies  either  directly  or 
in  cooperation  with  other  private  organizations,  or  shall 
it  be  done  by  the  state  ?  That  is,  should  rating  be  a  pub- 
lic or  a  private  function  ?  It  is  assumed  that  it  is  desir- 
able to  have  the  rating  done  in  a  uniform  manner,  that 
is,  that  the  rating  is  a  monopolistic  and  not  a  competi- 
tive activity. 

The  Control  of  Rates  by  a  State.  —  It  is  not  longer  a 
question  whether  the  state  has  the  legal  power  to  fix 
the  rates  in  fire  insurance.  The  Supreme  Court  of  the 
United  States  decided  this  question  in  the  case  of  German 
Alliance  Insurance  Company  vs.  Lewis  (24  N.  S.  Sup.  Ct. 
Rep.  612)  decided  April  20,  1914.  In  this  case  the  court 
remarked : 

"We  may  venture  to  observe  that  the  price  of  insurance  is  not 
fixed  over  the  counters  of  the  companies  by  what  Adam  Smith 


RATES  AND  RATING  135 

calls  the  higgling  of  the  market,  but  formed  in  the  councils  of  the 
underwriters,  promulgated  in  schedules  of  practically  controlling 
constancy  which  the  applicant  for  insurance  is  powerless  to  propose, 
and  which,  therefore,  has  led  to  the  assertion  that  the  business  of 
insurance  is  of  monopolistic  character  and  that  'it  is  illusory  to 
speak  of  a  liberty  of  contract.'  It  is  in  the  alternative  presented 
of  accepting  the  rates  of  the  companies  or  refraining  from  insurance 
business  necessity  impelling  if  not  compelling  it,  that  we  may 
discover  the  inducement  of  the  Kansas  statute ;  and  the  problem 
presented  is  whether  the  legislature  could  regard  it  of  as  such 
moment  to  the  public  that  they  who  seek  insurance  should  be  no 
more  constrained  by  arbitrary  terms  than  they  who  seek  trans- 
portation by  railroad,  steam,  or  street  or  by  coaches  whose  itin- 
erary may  be  only  a  few  city  blocks  or  who  seek  the  use  of  grain 
elevators  or  to  be  secured  in  a  night's  accommodation  at  a  wayside 
inn  or  in  the  weight  of  a  5  cent  loaf  of  bread.  We  do  not  say  this 
to  belittle  such  rights  or  to  exaggerate  the  efforts  of  insurance  but 
to  exhibit  the  principle  which  exists  in  all  and  brings  all  under  the 
same  governmental  power." 

The  power  of  each  state  over  the  fire  insurance  busi- 
ness is  limited  only  by  constitutional  guarantees.  It  is 
not  interstate  commerce.  The  rate  for  insurance  is  under 
complete  control  of  the  state.  It  is  not  therefore  a 
question  either  of  lack  of  power  to  fix  rates  or  of  any 
theoretical  inability  to  do  so.  There  is  no  legal  reason 
why  the  state  could  not  do  what  the  companies  and 
other  organizations  are  now  doing  in  respect  to  estab- 
lishing rates.  It  is  a  question  of  what  advantages  are 
to  be  gained  by  a  system  of  state-made  rates  under  which 
the  state  by  a  department  with  a  very  large  force  of 
employees  would  do  what  is  now  done  and  what  can  be 
controlled  in  minutest  detail.  The  state  would,  under 
a  system  of  state-made  rates  either :  (a)  fix  maximum 


136  PRINCIPLES  OF  INSURANCE 

rates;  or  (&)  fix  specific  rates;  or  (c)  supervise  rates, 
compel  adjustments,  and  otherwise  supervise  the  rate- 
making  and  its  application.  Some  attempts,  notably 
in  Texas,  have  been  made  to  establish  rates  by  state 
authority  but  the  success  or  advantage  is,  so  far  as 
results  have  shown,  very  doubtful.  There  would  be  as 
much  dissatisfaction  from  local  communities  under  state- 
made  rates  as  there  now  is  and  with  greater  opportunity 
to  make  these  local  protests  heard  in  readjusting  the  rate. 
The  Pennsylvania  Commission  appointed  to  investi- 
gate fire  insurance  companies  reported  as  follows  on 
this  point : 

"While  State  rating  might  possibly  be  considered  in  a  com- 
munity with  a  small  number  of  risks,  the  proposition  in  a  state  like 
Pennsylvania  would  be  a  stupendous  and  expensive  one  to  embark 
in.  Certainly,  no  one,  fully  acquainted  with  the  facts,  would  ask 
or  advise  that  the  State,  either  by  statute  or  through  a  commis- 
sioner or  commission,  fix  the  price  of  fire  insurance.  Besides,  no 
honest  man  could  object  to  a  law  to  recompense  the  company 
in  case  the  rate  proved  inadequate  to  meet  the  loss.  Should  a 
conflagration  occur  in  any  one  of  the  cities,  the  State  might  be 
called  upon  to  make  good  an  immense  sum.  The  San  Francisco 
loss  would  have  entailed  upon  California  a  debt  of  over  a  hundred 
million  dollars.  ...  A  careful  reading  of  our  report  should 
quickly  convince  any  one  that  the  fire  insurance  business  hi  Penn- 
sylvania, with  its  eight  millions  of  people  and  billions  of  property 
liable  to  fire  losses,  so  located  that  to  solve  the  problem  of  equi- 
table rates  of  premium,  under  the  countless  varying  conditions, 
would  call  for  an  army  of  experts  to  find  the  proper  rate's  and  keep 
informed  of  the  constant  changing  of  conditions,  and  would  re- 
quire a  new  Department,  supervised  by  a  corps  of  the  ablest 
insurance  men  in  the  world,  aided  by  a  force  of  at  least  three  to 
five  hundred  clerks  and  from  three  to  four  hundred  field  men  and  — 


RATES  AND   RATING  137 

in  order  to  accommodate  the  public  —  not  less  than  five  thousand 
agents.  Government  control  of  any  of  the  public  utilities  would  be 
a  much  simpler  proposition.  To  attempt  it,  is  impracticable, 
as  the  revenue  is  not  in  sight  to  provide  the  necessary  reserve  to 
give  the  public  proper  protection.  There  are  many  congested 
districts  in  Pennsylvania  where  a  conflagration  might  occur  at 
any  moment  and  the  State  might  be  called  upon  to  make  good  a 
loss  of  many  million  dollars.  Without  providing  a  large  reserve, 
the  proposition  would  be  absolutely  impracticable.  Individuals 
carry  several  millions  of  dollars  on  single  properties. 

"  Your  Commission  feels  that  a  Department,dealing  with  a  propo- 
sition requiring  such  a  large  force  of  employees  and  with  a  subject 
so  complex  and  so  close  to  every  property  holder,  and  one  so  im- 
possible to  reduce  to  a  common  standard,  would  soon  hear  the  cry 
that  favoritism  was  being  practiced  through  political  intrigue ; 
that  the  whole  Department  would  soon  be  in  disgrace,  whether 
rightfully  or  wrongfully  accused ;  that  public  sentiment  would 
quickly  ask  for  the  repeal  of  the  law  and  the  abandonment  of  the 
whole  proposition.  Strange  as  it  may  seem,  that  portion  of  the 
public  which  cries  loudest  for  government  control  complains  more 
against  the  supposed  general  dishonesty  of  public  officials." 

Summarizing  the  discussion  of  rates  we  find  : 
First,  that  in  the  early  period  rates  were  based  largely 
upon  the  judgment  of  what  underwriters  and  company 
officials  thought  the  hazard  of  a  risk  or  classes  of  risks  was. 
Second,  that  as  experience  accumulated  and  the  science 
and  art  of  fire  underwriting  developed,  there  came  to  be 
a  more  careful  analysis  of  the  hazard.  Schedules  were 
invented  which  were  applied  to  some  of  the  more  impor- 
tant classes  of  risks.  Third,  that  classification  of  risks 
according  to  occupancy  is  an  aid  but  not  a  solution  of 
the  rating  problem.  Fourth,  that  the  rating  problem 
will  always  remain  a  problem  because  of  the  numerous 


138  PRINCIPLES  OF  INSURANCE 

changes  in  the  different  kinds  of  hazard.  Fifth,  that 
competition  has  no  place  in  rate-making.  Sixth,  that 
the  public  can  secure  by  public  regulation  of  rate-making 
and  its  application  all  the  advantages  which  it  would  ob- 
tain from  a  system  of  rates  made  under  public  authority. 

REFERENCES 

Report  of  the  Joint  Legislature  Committee  of  Pennsylvania  on 

Fire  Insurance,  1913. 

New  York  Insurance  Report,  Part  I,  1914. 
Report  of  the  Joint  Committee  of  the  Senate  and  Assembly  of 

New  York  on  Fire  Insurance,  1911. 
Lectures  on  Fire  Insurance. 
Fire  Insurance  Classification.    A.  F.  Dean. 
Fire  Insurance  Rates  and  State  Regulation.    W.  F.  Gephart, 

Quarterly  Journal  of  Economics,  Vol.  XXVIII,  1914. 
The  Business  of  Insurance,  Vol.  I,  Chap.  V. 
Report  of  Illinois  Fire  Insurance  Commission  of  Illinois,  1911. 
Insurance  Year  Book,  1914. 
Fire  Hazard.    A.  F.  Dean. 

Proceedings  of  National  Board  of  Fire  Underwriters,  1915. 
Fire  Rating  as  a  Science.    A.  F.  Dean. 
Yale  Readings  in  Insurance  (Fire  Insurance),  Chaps.  V,  VI. 
Insurance  and  the  State.    W.  F.  Gephart. 


CHAPTER  VII 

THE   POLICY   CONTRACT 

The  Policy  Defined.  —  The  policy  in  fire  insurance  is  a 
contract,  made  by  the  insurer  and  the  insured,  under  the 
terms  of  which  the  insurer  agrees  to  indemnify  the  insured 
for  loss  suffered  to  his  property  as  a  direct  and  immediate 
result  of  fire.  The  contract  is  a  personal  contract  of 
indemnity,  and  an  accurate  understanding  should  be  had 
of  what  is  meant  by  indemnity.  In  life  insurance  the 
contract  is  not  based  upon  any  actual  or  imagined  in- 
demnity suffered  by  the  insured  or  his  dependents  or  his 
beneficiaries.  Human  life  does  not  lend  itself  to  an  easy 
valuation.  But  property  is  a  tangible  thing  with  a  value. 

Nature  of  the  Contract.  —  The  fire  insurance  contract 
is  an  agreement  whereby  the  insured,  by  the  payment  of 
a  certain  sum  and  the  compliance  with  other  conditions, 
is  entitled  in  the  case  of  a  fire  to  receive  from  the  insurer 
the  value  of  the  property  destroyed  or  such  part  of  the 
value  of  the  property  as  he  has  insured.  The  insured 
does  not  essentially  purchase  so  many  dollars'  worth  of 
insurance,  but  by  the  payment  of  a  premium,  based  upon 
an  analysis  of  the  fire  hazards  of  his  particular  property, 
he  guarantees  or  insures  that  he  will  have  the  use  of  his 
property,  free  from  destruction  by  fire ;  that  is,  the  in- 
surer indemnifies  him  for  such  property  as  has  been  de- 
stroyed. Too  much  emphasis  cannot  be  laid  upon  this 

139 


i4o  PRINCIPLES  OF  INSURANCE 

indemnity  character  of  the  fire  insurance  contract,  for  it 
is  frequently  misunderstood  by  the  public.  This  error 
has  been  the  source  of  much  ill-advised  legislation  which 
permitted  the  insured  to  recover,  not  what  he  lost  by 
fire,  but  "  that  amount  of  dollars  of  insurance  "  which 
it  was  believed  he  had  purchased.  Fire  insurance  protec- 
tion cannot  be  considered  as  distinct  from  property.  It 
is  not  a  quantity  which  is  sold  as  an  ordinary  commodity, 
such  as  wheat,  by  the  unit  measure.  It  is  indemnity, 
that  is,  what  was  actually  lost  by  the  occurrence  of  fire. 

A  Personal  Contract.  —  The  contract  of  fire  insurance 
is  also  a  personal  contract.  This  may  appear  to  be  in 
opposition  to  what  has  just  been  stated,  but  the  contract 
insures  not  property  but  persons.  There  is,  however, 
no  conflict  in  the  two  statements.  It  is  personal  in  the 
sense  that  it  is  made  with  an  individual  who  has  an 
interest  in  the  property  insured.  It  is  on  the  property 
for  the  benefit  of  its  owner  or  one  who  has  a  valuable 
interest  therein.  The  policy  does  not  follow  the  property. 
It  is  a  contract  made  with  the  insured  to  indemnify  him 
for  a  loss,  and  if  the  control  of  the  property  passes  from 
him  to  another,  he  has  no  claim  to  indemnity,  since  he 
can  suffer  no  loss.  The  character  of  the  owner  may, 
as  has  been  shown,  affect  the  probability  of  a  loss ;  that 
is,  carelessness  in  its  use,  or  personal  dishonesty,  may  so 
affect  the  hazard,  that  the  insurer  would  not  be  willing 
to  insure  the  property  at  any  price  when  its  control  passes 
from  one  person  to  another. 

The  policy  is  based  upon  the  assumption  that  the  ut- 
most good  faith  will  be  displayed  by  the  insured.  It  is 
true  that  the  contract  has  been  made  by  the  insurer,  and 


THE  POLICY  CONTRACT  141 

presumably  he  has  protected,  so  far  as  is  possible,  his 
interests  by  the  provisions  of  the  contract.  Yet  the 
property  is  in  the  possession  and  under  the  control  of  the 
insured.  The  insurer  has  no  means  either  of  completely 
knowing  all  the  conditions  of  the  property  at  the  time  the 
contract  is  consummated  and  the  character  of  the  insured, 
or  of  later  knowing  whether  the  insured  is  fully  complying 
with  all  the  conditions  of  the  policy.  While  the  insurer 
may  have  the  position  of  advantage  before  the  contract 
is  entered  into,  the  insured  has  that  position  later. 

Early  Policies.  —  Fire  insurance  policies  date  from 
1667,  although  earlier  contracts  were  probably  made ; 
but  authentic  records  date  from  this  year.  Marine  in- 
surance had,  preceding  this  date,  considerable  develop- 
ment, and  the  early  fire  insurance  policies  had  the  benefit 
of  the  experience  under  these  policies.  The  early  policies 
were  very  simple  as  compared  with  those  of  the  present, 
although  from  the  very  fact  that  such  policies  have  been 
in  existence  for  over  two  hundred  years  and  have  received 
application  and  interpretation  by  courts,  insurer,  and  in- 
sured, there  has  developed  a  body  of  principles,  specific 
application  of  words  and  phrases,  which  are  of  great  serv- 
ice. The  early  policies  were  brief,  but  there  was  also  a 
prospectus,  issued  by  the  company,  which  was  referred 
to  in  the  policy  and  made  a  part  of  it.  Both  the  policy 
and  the  prospectus  in  case  of  a  legal  dispute  were  used  in 
applying  the  contract.  In  time,  the  prospectus  became  a 
part  of  the  contract. 

In  the  United  States,  the  early  policies,  as  well  as 
the  companies,  were  patterned  upon  those  in  England. 
Since  much  of  our  law  and  legal  procedure  is  based  upon 


I42  PRINCIPLES  OF  INSURANCE 

or  derived  from  that  of  England,  the  numerous  court 
decisions  and  interpretations  which  the  fire  insurance 
policy  received  in  the  English  courts  were  available  for 
our  courts.  Almost  every  line  and  phrase  of  the  fire  in- 
surance policy  has  been  a  subject  of  litigation  during  this 
long  period,  and  a  large  amount  of  legal  interpretation  is 
available  as  to  what  the  contract  means.  This  ex- 
plains largely  why  the  present  policy  retains  many  of 
these  early  phrases  or  other  modernized  phrases  with  the 
same  meaning.  Such  a  contract  needs  to  be  standardized, 
and  its  importance  is  so  great  and  the  interests  which 
it  concerns  so  momentous,  that  changes  should  not  be 
made  for  trivial  reasons. 

When  fire  insurance  companies  were  organized  in  this 
country,  each  company  drew  up  its  own  contract  with 
whatever  terms  it  pleased.  Naturally  there  was  con- 
siderable similarity,  but  as  the  companies  increased  in 
numbers,  as  competition  for  business  became  more  active, 
and  as  many  different  kinds  of  property  in  many  different 
territories  with  widely  varying  conditions  in  respect  to 
hazard  developed,  there  came  to  be  a  great  variation  in 
the  policy  contracts.  This  led  to  endless  confusion  and 
frequent  litigation.  Some  states  required  certain  pro- 
visions to  be  in  all  fire  insurance  policies,  but  this  left 
large  opportunity  for  modification  to  suit  the  conven- 
ience of  the  individual  companies.  Some  companies 
endeavored  to  attract  business  by  the  terms  of  the 
policy,  and  not  infrequently  drew  these  clauses  in  such 
a  clever  manner,  that  they  secured  the  business,  but  were 
often  relieved  of  liability  when  a  suit  was  instituted  to 
enforce  the  payment  of  the  policy. 


THE  POLICY  CONTRACT  143 

When  the  National  Board  of  Underwriters  was  organ- 
ized in  1866,  a  uniform  policy  was  drawn  up,  but  this 
Board  had  no  power  other  than  moral  suasion  to  compel 
its  adoption.  The  personal  interests  of  the  companies 
were  so  much  greater  in  retaining  their  own  policy  that 
they  did  not  adopt  this  uniform  policy.  Self-interest 
thus  prevailed  over  moral  persuasion.  Each  company 
continued  free  to  use  its  own  policy.  In  1873  the  state 
of  Massachusetts  adopted  a  uniform  policy,  but  its  use 
by  the  companies  was  voluntary  until  1881  when  its  use 
by  all  fire  insurance  companies  doing  business  in  Massa- 
chusetts was  made  compulsory.  In  1886  the  state  of 
New  York  adopted  a  standard  policy,  and  its  use  was 
made  mandatory  beginning  with  January  15,  1887. 

Importance  of  Standard  Policies.  —  The  experience  in 
the  earlier  years  made  clear  the  necessity  of  having  a 
standard  policy,  that  is,  either  a  policy  with  its  provisions 
stated  in  great  detail,  or  such  standard  provisions  as 
would  cover  all  the  more  important  aspects  of  the  con- 
tract. The  very  character  of  the  contract  is  one  which 
makes  large  opportunities  for  misunderstanding  and 
invites  litigation.  That  protection  which  it  grants 
becomes  all  important  at  the  time  of  a  loss.  The  in- 
sured seldom  knows  or  ordinarily  can  know  much  in 
reference  to  the  details  of  this  technical  subject.  His 
interests  must  be  protected  by  the  state,  and  this  is  done 
in  part  by  the  standard  policy.  These  standard  pro- 
visions receive  interpretation  by  the  courts,  and  as  they 
are  applied,  certainty  as  to  the  meaning  replaces  un- 
certainty. The  field  of  litigation  grows  smaller.  Seven- 
teen states  have  adopted  a  standard  policy,  and  this  num- 


144  PRINCIPLES  OF  INSURANCE 

ber  includes  almost  all  the  important  states  from  the 
standpoint  of  property  value.  Of  these  states  all  except 
three  use  the  New  York  form  of  the  Standard  Policy; 
two  use  the  Massachusetts  form  ;  other  states  have  what 
is  practically  a  Standard  Policy.1  The  particular  form  of 
the  Standard  Policy  is  modified  in  some  relatively  unim- 
portant details  to  suit  the  local  conditions  or  to  meet 
local  prejudices.  There  remains  a  large  similarity  in  all 
the  Standard  Policies  and  the  following  form  is  given  as 
typical : 

Standard  Fire  Insurance  Policy 

THE FIRE    INSURANCE    COMPANY 

IN  CONSIDERATION  of  the  Stipulations  herein  named  and 

of   

DOLLARS  PREMIUM 

(a)  Does  Insure for  the  term  of 

from  the day  of 

ip. .,  at  noon,  to  the day  of 

ig . . ,  at  noon, 

To  an  amount  not  exceeding 

Dollars,  to  the  following  described  property  while  located  and 
contained  as  described  herein,  and  not  elsewhere,  to  wit : 

(b)  This  company  shall  not  be  liable  beyond  the  actual 
cash  value  of  the  property  at  the  time  any  loss  or  damage 
occurs,  and  the  loss  or  damage  shall  be  ascertained  or  esti- 
mated according  to  such  actual  cash  value,  with  proper  deduc- 

1  The  association  of  the  Insurance  Commissioners  of  the  various  states 
has  drawn  up  a  revised  Standard  Policy,  but  since  all  the  provisions  of 
the  older  Standard  Policy  are  found  in  this  revised  form  and  constitute 
the  chief  provisions,  the  older  form  is  made  the  basis  of  the  discussion. 


THE  POLICY  CONTRACT  145 

tion  for  depreciation  however  caused,  and  shall  in  no  event 
exceed  what  it  would  then  cost  the  insured  to  repair  or  replace 
the  same  with  material  of  like  kind  and  quality;  said  ascer- 
tainment or  estimate  shall  be  made  by  the  insured  and  this 
company,  or,  if  they  differ,  then  by  appraisers,  as  hereinafter 
provided;  and,  the  amount  of  loss  or  damage  having  been 
thus  determined,  the  sum  for  which  this  company  is  liable 
pursuant  to  this  policy  shall  be  payable  sixty  days  after  due 
notice,  ascertainment,  estimate,  and  satisfactory  proof  of 
the  loss  have  been  received  by  this  company  in  accordance 
with  the  terms  of  this  policy.  It  shall  be  optional,  however, 
with  this  company  to  take  all,  or  any  part,  of  the  articles  at 
such  ascertained  or  appraised  value,  and  also  to  repair, 
rebuild,  or  replace  the  property  lost  or  damaged  with 
other  of  like  kind  and  quality  within  a  reasonable  time 
on  giving  notice,  within  thirty  days  after  the  receipt  of 
the  proof  herein  required,  of  its  intention  so  to  do;  but 
there  can  be  no  abandonment  to  this  company  of  the 
property  described. 

(c)  This  entire  policy  shall  be  void  if  the  insured  has 
concealed  or  misrepresented,  in  writing  or  otherwise,  any 
material  fact  or  circumstance  concerning  this  insurance  or 
the  subject  thereof;  or  if  the  interest  of  the  insured  in  the 
property  be  not  truly  stated  herein;  or  in  case  of  any  fraud 
or  false  swearing  by  the  insured  touching  any  matter  relat- 
ing to  this  insurance  or  the  subject  thereof,  whether  before 
or  after  a  loss. 

(d)  This  entire  policy,    unless   otherwise  provided  by 
agreement  indorsed  hereon  or  added  hereto,  shall  be  void  if 
the  insured  now  has  or  shall  hereafter  make  or  procure  any 
other  contract  of  insurance,  whether  valid  or  not,  on  property 

L 


i46  PRINCIPLES  OF  INSURANCE 

covered  in  whole  or  in  part  by  this  policy;  or  if  the  subject 
of  insurance  be  a  manufacturing  establishment  and  it  be 
operated  in  whole  or  in  part  at  night  later  than  10  o'clock, 
or  if  it  cease  to  be  operated  for  more  than  ten  consecutive 
days;  or  if  the  hazard  be  increased  by  any  means  within 
the  control  or  knowledge  of  the  insured;  or  if  mechanics  be 
employed  in  building,  altering,  or  repairing  the  within- 
described  premises  for  more  than  fifteen  days  at  any  one 
time;  or  if  the  interest  of  the  insured  be  other  than  uncondi- 
tional and  sole  ownership;  or  if  the  subject  of  insurance  be  a 
building  on  ground  not  owned  by  the  insured  in  fee-simple ; 
or  if  the  subject  of  insurance  be  personal  property  and  be 
or  become  incumbered  by  a  chattel  mortgage;  or  if,  with  the 
knowledge  of  the  insured,  foreclosure  proceedings  be  com- 
menced or  notice  given  of  sale  of  any  property  covered  by 
this  policy  by  virtue  of  any  mortgage  or  trust  deed;  or  if 
any  change,  other  than  by  the  death  of  an  insured,  take  place 
in  the  interest,  title,  or  possession  of  the  subject  of  insurance 
(except  change  of  occupants  without  increase  of  hazard], 
whether  by  legal  process  or  judgment  or  by  voluntary  act  of 
the  insured,  or  otherwise;  or  if  this  policy  be  assigned  before 
a  loss;  or  if  illuminating  gas  or  vapor  be  generated  in  the 
described  building  (or  adjacent  thereto}  for  use  therein;  or 
if  (any  usage  or  custom  of  trade  or  manufacture  to  the  con- 
trary notwithstanding)  there  be  kept,  used,  or  allowed  on  the 
above-described  premises,  benzine,  benzole,  dynamite,  ether, 
fireworks,  gasoline,  greek  fire,  gunpowder  exceeding  twenty- 
five  pounds  in  quantity,  naphtha,  nitroglycerine  or  other 
explosives,  phosphorus,  or  petroleum  or  any  of  its  products 
of  greater  inflammability  than  kerosene  oil  of  the  United 
States  standard  (which  last  may  be  used  for  lights  and  kept 


THE  POLICY  CONTRACT  147 

for  sale  according  to  law,  but  in  quantities  not  exceeding  five 
barrels,  provided  it  be  drawn  and  lamps  filled  by  daylight 
or  at  a  distance  not  less  than  ten  feet  from  artificial  light] ; 
or  if  a  building  herein  described,  whether  intended  for  occu- 
pancy by  owner  or  tenant,  be  or  become  vacant  or  unoccupied 
and  so  remain  for  ten  days. 

(e)  This  company  shall  not  be  liable  for  loss  caused  di- 
rectly or  indirectly  by  invasion,  insurrection,  riot,  civil  war 
or  commotion,  or  military  or  usurped  power,  or  by  order  of 
any  civil  authority;  or  by  theft;  or  by  neglect  of  the  insured 
to  use  all  reasonable  means  to  save  and  preserve  the  property 
at  and  after  afire  or  when  the  property  is  endangered  by  fire 
in  neighboring  premises;  or  (unless  fire   ensues,  and,  in 
that  event,  for  the  damage  by  fire  only)  by  explosion  of  any 
kind,  or  lightning;  but  liability  for  direct  damage  by  light- 
ning may  be  assumed  by  specific  agreement  hereon. 

(f)  //  a  building  or  any  part  thereof  fall,  except  as  the 
result  of  fire,  all  insurance  by  this  policy  on  such  building 
or  its  contents  shall  immediately  cease. 

(g)  This  company  shall  not  be  liable  for  loss  to  accounts, 
bills,  currency,  deeds,  evidences  of  debt,  money,  notes,  or 

,  securities;  nor,  unless  liability  is  specifically  assumed 
hereon,  for  loss  to  awnings,  bullion,  casts,  curiosities, 
drawings,  dies,  implements,  jewels,  manuscripts,  medals, 
models,  patterns,  pictures,  scientific  apparatus,  signs,  store 
or  office  furniture  or  fixtures,  sculpture,  tools,  or  property 
held  on  storage  or  for  repairs;  nor,  beyond  the  actual  value 
destroyed  by  fire,  for  loss  occasioned  by  ordinance  or  law 
regulating  construction  or  repair  of  buildings,  or  by  inter- 
ruption of  business,  manufacturing  processes,  or  otherwise; 
nor  for  any  greater  proportion  of  the  value  of  plate  glass, 


i48  PRINCIPLES  OF  INSURANCE 

| 

frescoes,  and  decorations  than  that  which  this  policy  shall 
bear  to  the  whole  insurance  on  the  building  described. 

(h)  //  an  application,  survey,  plan,  or  description  of 
property  be  referred  to  in  this  policy  it  shall  be  a  part  of  this 
contract  and  a  warranty  by  the  insured. 

(i)  In  any  matter  relating  to  this  insurance  no  person, 
unless  duly  authorized  in  writing,  shall  be  deemed  the  agent 
of  this  company. 

(j)  This  policy  may  by  a  renewal  be  continued  under  the 
original  stipulations,  in  consideration  of  premium  for  the 
renewed  term,  provided  that  any  increase  of  hazard  must 
be  made  known  to  this  company  at  the  time  of  renewal  or  this 
policy  shall  be  void. 

(k)  This  policy  shall  be  canceled  at  any  time  at  the 
request  of  the  insured;  or  by  the  company  by  giving  five 
days'  notice  of  such  cancellation.  If  this  policy  shall  be 
canceled  as  hereinbefore  provided,  or  become  void  or  cease, 
the  premium  having  been  actually  paid,  the  unearned 
portion  shall  be  returned  on  surrender  of  this  policy 
or  last  renewal,  this  company  retaining  the  customary 
short  rate;  except  that  when  this  policy  is  canceled  by 
this  company  by  giving  notice,  it  shall  retain  only  the  pro 
rata  premium. 

(1)  //,  with  the  consent  of  this  company,  an  interest 
under  this  policy  shall  exist  in  favor  of  a  mortgagee  or  of  any 
person  or  corporation  having  an  interest  in  the  subject  of 
insurance  other  than  the  interest  of  the  insured  as  described 
herein,  the  conditions  hereinbefore  contained  shall  apply  in 
the  manner  expressed  in  such  provisions  and  conditions  of 
insurance  relating  to  such  interest  as  shall  be  written  upon, 
attached,  or  appended  hereto. 


THE  POLICY  CONTRACT  149 

(m)  //  property  covered  by  this  policy  is  so  endangered  by 
fire  as  to  require  removal  to  a  place  of  safety,  and  is  so 
removed,  that  part  of  this  policy  in  excess  of  its  proportion 
of  any  loss  and  of  the  value  of  property  remaining  in  the 
original  location  shall,  for  the  ensuing  five  days  only,  cover 
the  property  so  removed  in  the  new  location;  if  the  removal 
to  more  than  one  location,  such  excess  of  this  policy  shall 
cover  therein  for  such  five  days  in  the  proportion  that  the 
value  in  any  one  such  new  location  bears  to  the  value  in  all 
such  new  locations;  but  this  company  shall  not,  in  any  case 
of  removal,  whether  to  one  or  more  locations,  be  liable  beyond 
the  proportion  that  the  amount  hereby  insured  shall  bear 
to  the  total  insurance  on  the  whole  property  at  the  time  of 
fire,  whether  the  same  cover  in  new  location  or  not. 

(n)  If  fire  occur,  the  insured  shall  give  immediate  notice 
of  any  loss  thereby  in  writing  to  this  company,  protect  the 
property  from  further  damage,  fortJrwith  separate  the 
damaged  and  undamaged  personal  property,  put  it  in  the 
best  possible  order,  make  a  complete  inventory  of  the  same, 
stating  the  quantity  and  cost  of  each  article  and  the  amount 
claimed  thereon;  and,  within  sixty  days  after  the  fire,  unless 
such  time  is  extended  in  writing  by  this  company,  shall  render 
a  statement  to  this  company,  signed  and  sworn  to  by  said 
insured,  stating  the  knowledge  and  belief  of  the  insured  as 
to  the  time  and  origin  of  the  fire;  the  interest  of  the  insured 
and  of  all  others  in  the  property;  the  cash  value  of  each  item 
thereof  and  the  amount  of  the  loss  thereon;  all  incumbrances 
thereon;  all  other  insurance,  whether  valid  or  not,  covering 
any  of  said  property;  and  a  copy  of  all  the  descriptions  and 
schedules  in  all  policies;  any  changes  in  the  title,  use, 
occupation,  location,  possession,  or  exposures  of  said 


ISO  PRINCIPLES  OF  INSURANCE 

property  since  the  issuing  of  this  policy;  by  whom  and  for 
what  purpose  any  building  herein  described  and  the  several 
parts  thereof  were  occupied  at  the  time  of  fire;  and  shall 
furnish,  if  required,  verified  plans  and  specifications  of  any 
building,  fixtures,  or  machinery  destroyed  or  damaged; 
and  shall  also,  if  required,  furnish  a  certificate  of  the 
magistrate  or  notary  public  (not  interested  in  the  claim  as  a 
creditor  or  otherwise,  nor  related  to  the  insured]  living 
nearest  the  place  of  fire,  stating  that  he  has  examined  the 
circumstances  and  believes  the  insured  has  honestly  sus- 
tained loss  to  the  amount  that  such  magistrate  or  notary 
public  shall  certify. 

(o)  The  insured,  as  often  as  required,  shall  exhibit  to  any 
person  designated  by  this  company  all  that  remains  of  any 
property  herein  described,  and  submit  to  examinations  under 
oath  by  any  person  named  by  this  company,  and  subscribe  the 
same;  and,  as  often  as  required,  shall  produce  for  examina- 
tion all  books  of  account,  bills,  invoices,  and  other  vouchers, 
or  certified  copies  thereof  if  originals  be  lost,  at  such  reason- 
able place  as  may  be  designated  by  this  company  or  its 
representative,  and  shall  permit  extracts  and  copies  thereof 
to  be  made. 

(p)  In  the  event  of  disagreement  as  to  the  amount  of  loss 
the  same  shall,  as  above  provided,  be  ascertained  by  two 
competent  and  disinterested  appraisers,  the  insured  and 
this  company  each  selecting  one,  and  the  two  so  chosen  shall 
first  select  a  competent  and  disinterested  umpire;  the  ap- 
praisers together  shall  then  estimate  and  appraise  the  loss, 
stating  separately  sound  value  and  damage,  and,  failing  to 
agree,  shall  submit  their  differences  to  the  umpire;  and  the 
award  in  writing  of  any  two  shall  determine  the  amount 


THE  POLICY  CONTRACT  151 

of  such  loss;  the  parties  thereto  shall  pay  the  appraiser 
respectively  selected  by  them  and  shall  bear  equally  the 
expenses  of  the  appraisal  and  umpire. 

(q)  This  company  shall  not  be  held  to  have  waived  any 
provision  or  condition  of  this  policy  or  any  forfeiture  thereof 
by  any  requirement,  act,  or  proceeding  on  its  part  relating 
to  the  appraisal  or  to  any  examination  herein  provided  for ; 
and  the  loss  shall  not  become  payable  until  sixty  days  after 
the  notice,  ascertainment,  estimate,  and  satisfactory  proof 
of  the  loss  herein  required  have  been  received  by  this  company, 
including  an  award  by  appraisers  when  appraisal  has  been 
required. 

(r)  This  company  shall  not  be  liable  under  this  policy 
for  a  greater  proportion  of  any  loss  on  the  described  property, 
or  for  loss  by  and  expense  of  removal  from  premises  en- 
dangered by  fire,  than  the  amount  hereby  insured  shall 
bear  to  the  whole  insurance,  whether  valid  or  not,  or  by 
solvent  or  insolvent  insurers,  covering  such  property, 
and  the  extent  of  the  application  of  the  insurance  under 
this  policy  or  of  the  contribution  to  be  made  by  this  com- 
pany in  case  of  loss,  may  be  provided  for  by  agreement 
or  condition  written  hereon  or  attached  or  appended 
hereto.  Liability  for  re-insurance  shall  be  as  specifically 
agreed  hereon. 

(s)  //  this  company  shall  claim  that  the  fire  was  caused 
by  the  act  or  neglect  of  any  person  or  corporation,  private  or 
municipal,  this  company  shall,  on  payment  of  the  loss,  be 
surrogated  to  the  extent  of  such  payment  to  all  right  of 
recovery  by  the  insured  for  the  loss  resulting  therefrom,  and 
such  right  shall  be  assigned  to  this  company  by  the  insured 
on  receiving  such  payment. 


1 52  PRINCIPLES  OF  INSURANCE 

(t)  No  suit  or  action  on  this  policy,  for  the  recovery  of  any 
claim,  shall  be  sustainable  in  any  court  of  law  or  equity  until 
after  full  compliance  by  the  insured  with  all  the  foregoing  re- 
quirements, nor  unless  commenced  within  twelve  months 
next  after  the  fire. 

(u)  Wherever  in  this  policy  the  word  "insured"  occurs, 
it  shall  be  held  to  include  the  legal  representative  of  the  in- 
sured, and  wherever  the  word  "loss"  occurs,  it  shall  be 
deemed  the  equivalent  of  "loss  or  damage." 

(v)  //  this  policy  be  made  by  a  mutual  or  other  company 
having  special  regulations  lawfully  applicable  to  its  organi- 
zation, membership,  policies  or  contracts  of  insurance,  such 
regulations  shall  apply  to  and  form  a  part  of  this  policy  as 
the  same  may  be  written  or  printed  upon,  attached,  or  ap- 
pended hereto. 

(w)  This  policy  is  made  and  accepted  subject  to  the  fore- 
going stipulations  and  conditions,  together  with  such  other 
provisions,  agreements,  or  conditions  as  may  be  indorsed 
hereon  or  added  hereto,  and  no  officer,  agent,  or  other  repre- 
sentative of  this  company  shall  have  power  to  waive  any 
provision  or  condition  of  this  policy  except  such  as  by  the 
terms  of  this  policy  may  be  the  subject  of  agreement  indorsed 
hereon  or  added  hereto,  and  as  to  such  provisions  and  condi- 
tions no  officer,  agent,  or  representative  shall  have  such  power 
or  be  deemed  or  held  to  have  waived  such  provisions  or  condi- 
tions unless  such  waiver,  if  any,  shall  be  written  upon  or 
attached  hereto,  nor  shall  any  privilege  or  permission  affect- 
ing the  insurance  under  this  policy  exist  or  be  claimed  by 
the  insured  unless  so  written  or  attached. 

(x)  IN  WITNESS  WHEREOF,  this  company  has  executed 

and  attested  these  presents  this 

day  of 19 .. 


THE  POLICY  CONTRACT  153 

(y)  This  Policy  shall  not  be  valid  until  Countersigned  by 
the  duly  authorized  Agent  of  the  Company  at 


President 

Secretary 

(z)  Countersigned  by 

Agent. 

Explanation  of  the  Standard  Policy.  —  Attention  may 
now  be  directed  to  some  of  the  more  important  pro- 
visions of  this  standard  policy,  reserving  for  a  later 
discussion  the  subjects  which  pertain  to  the  settlement 
of  the  loss. 

In  the  opening  statement,  the  person  insured,  the 
length  of  the  insurance,  the  consideration  and  the  prop- 
erty, as  to  description  and  location,  are  covered. 

The  Personal  and  Time  Element.  —  The  contract  is  a 
personal  one.  Persons  are  insured  against  the  loss  of 
their  property,  and  any  change  of  ownership  in  the  prop- 
erty results  in  a  termination  of  the  insurance  with  a  right 
of  refund  for  such  part  of  the  premium  as  has  been  paid, 
which  has  not  been  earned  by  the  insurer.  The  duration 
of  the  insurance  is  fixed  from  a  stated  day  at  noon  until 
a  certain  later  day  at  noon.  Since  standard  time  has 
come  into  general  use  in  business  transactions,  the  noon 
stated  hi  most  cases  refers  to  twelve  o'clock  standard 
time  at  the  place  where  the  property  is  located.  Owing 
to  the  difference  in  opinion  on  this  point  and  the  various 
interpretations  by  the  courts  as  to  the  meaning  of  "  noon," 
some  states  have  specifically  defined  hi  laws  this  word. 
The  difference  in  standard  time  between  two  places,  as  for 


154  PRINCIPLES  OF  INSURANCE 

example  the  location  of  the  company  and  the  location  of 
the  property,  is  amply  sufficient  for  a  fire  to  occur. 

Policies  are  written  for  one  to  five  years.  In  1914  of 
the  one  hundred  and  ninety-one  joint  stock  companies 
reporting  to  the  state  of  New  York,  the  following  was  the 
distribution  of  their  business : 

POLICY  DURATION  AMOUNT 

One  year  or  less $17,037,299,417 

Two  years 487,310,936 

Three  years 27,048,883,742 

Four  years 378,553,3°8 

Five  years 11,060,811,926 

Combined  term  business 38,975,559,912 

Total  amount  covered] 56,012,859,329 

Direct  Loss.  —  The  insurance  is  against  direct  loss  or 
damage  by  fire.  Losses  may  occur  to  buildings  and 
contents  due  indirectly  to  fires,  and  not  infrequently  have 
the  courts  been  called  upon  to  decide  this  point.  A  fire 
in  an  adjoining  building  may  cause,  indirectly,  loss  to  the 
property  and  its  contents.  The  fire  may  be  a  secondary 
cause  or  an  effect,  as  when  a  cyclone  or  an  earthquake 
wrecks  a  building  and  a  fire  breaks  out  which  burns  a 
demolished  building  and  its  ruined  contents. 

The  maximum  amount  of  the  insurance  is  stated. 
The  greater  number  of  fires  cause  only  partial  losses. 
The  contract  is  one  of  indemnity :  that  is,  the  payment 
should  not  exceed  the  value  of  the  property  destroyed. 
It  is  a  general  principle  of  all  insurance  that  the  insured 
should  in  no  manner  gain  from  the  insurance  contract. 
Otherwise  a  necessary  burden  and  an  existing  risk  is  in- 
creased for  all  who  by  a  system  of  cooperation  are  seek- 
ing to  decrease  the  burden.  It  is  true,  as  will  be  shown 


THE  POLICY  CONTRACT  155 

later,  that  the  policy  may  not  represent  the  full  value  of 
the  property.  This  is  a  matter  of  contract  between  the 
insured  and  insurer. 

Location  and  Character  of  Property.  —  The  property 
is  described  as  to  location  and  character.  It  has  a  fixed 
location,  for  the  contract  specifies  the  insurance  is  on  the 
property  "  while  located  and  contained."  The  first  part 
refers  to  immovable  property  such  as  buildings,  in  which  a 
difference  as  to  its  location  even  in  a  particular  city  may 
have  great  significance.  One  building  may  have  near  it 
a  frame  structure  or  other  extra  hazardous  exposure. 
The  second  part  of  the  description  refers  to  movable 
property.  In  the  ordinary  policy  the  insurance  neither 
follows  the  owner  nor  its  changing  location.  The  re- 
moval of  goods  from  one  building  to  another  may  mate- 
rially increase  the  hazard,  and  except  when  there  is  a 
floating  or  blanket  policy,  the  insurance  terminates  with 
a  change  in  the  location  of  the  goods. 

Indemnification.  —  The  company  is  liable  only  for  the 
actual  cash  value  of  the  property  at  the  time  of  the  fire, 
for  the  insured  should  receive  not  what  he  has  not  lost, 
but  only  indemnification.  He  buys  insurance  not  as 
an  investment  with  the  expectation  of  deriving  a  dividend 
or  profit  from  his  expenditure  but  rather  with  the  object 
of  assuring  himself  that  he  may  regularly  continue  his 
business  from  which  he  derives  his  profit.  The  large 
flour  miller,  who  contracts  in  advance  with  a  wheat 
broker  for  a  supply  of  wheat  which  he  may  transform  into 
flour  for  sale  and  thus  derive  a  profit  from  his  business  of 
manufacturing  flour  and  not  from  speculating  in  wheat,  is 
essentially  buying  insurance  of  a  kind.  So  the  property 


156  PRINCIPLES  OF  INSURANCE 

owner  should  purchase  insurance  not  for  profit  but  for 
security.  It  will  be  shown  later  that  a  form  of  insurance, 
called  profit  insurance,  is  in  process  of  development,  but 
it  is  quite  different  from  fire  insurance,  which  is  indemnity 
for  loss  which  is  likely  to  come  to  the  individual,  wholly 
remote  from  any  act  on  his  part. 

Conditions  Voiding  the  Policy.  —  The  parts  of  the 
policy  enumerated  as  (c)  and  (d}  refer  to  the  condi- 
tions under  which  the  policy  becomes  void.  Conceal- 
ment or  misrepresentation  of  facts,  many  of  which  can 
be  known  only  to  the  insured,  make  the  policy  void. 
There  is  not,  as  in  life  insurance,  an  incontestability 
clause,  since  the  insurer  is  even  more  dependent  upon 
the  good  faith  and  honesty  of  the  insured  in  fire  insur- 
ance than  in  life  insurance.  To  verify  ownership  of 
property,  to  inspect,  all  property  minutely,  to  discover 
facts  which  are  known  to  the  insured  and  which  he  may 
reasonably  be  expected  to  disclose  to  the  insurer  as  the 
basis  of  the  contract,  would  require  a  very  large  addi- 
tion to  the  already  large  expenses  of  conducting  the  fire 
insurance  business. 

The  answer  to  these  questions  relating  to  the  material 
facts  of  the  risk  and  its  ownership  are  applied  by  the 
courts  as  warranties  and  not  as  representations.  The 
Supreme  Court  of  the  United  States  has  distinguished 
warranties  and  representations  in  this  connection  as 
follows :  "  The  difference  between  a  warranty  and  a  rep- 
resentation is  that  a  warranty  must  be  true,  while  a 
representation  must  be  true  only  so  far  as  the  represen- 
tation is  material  to  the  risk ;  and  it  is  material  when  a 
knowledge  of  the  truth  would  have  induced  the  insurer 


THE  POLICY  CONTRACT  157 

to  have  refused  the  risk  or  to  have  charged  a  higher  rate 
of  premium." 

In  the  paragraph  marked  (d)  there  is  stated  a  number 
of  circumstances  which  void  the  policy  unless  permission 
is  obtained  to  do  the  act  therein  prohibited.  The  grant- 
ing of  some  of  these  permits  is  a  matter  of  mere  formal- 
ity, but  in  the  absence  of  such  permission,  disputes  arise 
which  often  the  court  is  called  upon  to  determine.  This 
permission  takes  the  form  of  a  rider  or  permit  which  is 
attached  to  the  policy.  It  is  important  for  the  company 
to  know  if  there  is  any  other  insurance  on  the  property. 
The  moral  hazard  may  otherwise  be  present  in  a  large 
degree.  This  clause  should  be  considered  in  connection 
with  clause  (r),  in  which  the  company  assumes  liability 
only  in  proportion  to  the  whole  amount  of  insurance  in 
case  of  a  partial  loss.  Both  clauses  are  intended  to  pre- 
vent the  insured  from  receiving  more  insurance  than  his 
actual  loss ;  for,  as  has  been  previously  shown,  insurance 
is  not  essentially  a  quantitative  thing  which  can  be  pur- 
chased. Indemnity  is  the  thing  sold,  and  not  insurance 
by  the  hundred  dollars'  worth,  as  it  is  often  popularly 
supposed.  Every  dollar's  worth  of  insurance  paid  to  the 
insured  over  and  above  the  property  destroyed  is  paid 
by  other  property  holders.  Thus  collecting  insurance 
in  excess  of  loss  became  a  refined  method  of  theft,  which 
unfortunately  is  oftentimes  defended  by  property  holders 
and  state  legislatures  by  enacting  laws  which  make  such 
a  practice  possible. 

Each  of  the  other  circumstances  which  in  this  para- 
graph (d)  void  the  policy  in  some  manner  increase  the 
hazard.  Operating  factories  at  night,  repairing  buildings, 


158  PRINCIPLES  OF  INSURANCE 

the  storage  or  use  of  explosive  material,  placing  a  mort- 
gage on  the  property,  permitting  the  building  to  remain 
unused  or  unoccupied,  each  operates  to  increase  the 
physical  or  moral  hazard  of  the  risk.  Some  of  these 
prohibitions  may  be  the  subject  of  permits,  as  for  ex- 
ample provisions  for  the  repair  of  buildings.  The  mort- 
gage clause  is  very  important  and  will  be  discussed  in  the 
succeeding  chapter. 

Vacancy.  —  When  a  building  becomes  "  vacant  or 
unoccupied  "  has  been  a  subject  of  frequent  litigation, 
but  the  object  of  the  prohibition  is  clear.  The  absence 
of  individuals  from  a  property  increases  the  hazard,  since 
not  only  attention  may  be  given  to  a  building  by  the 
occupiers  which  will  prevent  a  fire,  but  if  one  breaks  out, 
the  presence  of  a  dweller  often  serves  to  prevent  a  serious 
loss.  Vacancy  permits  are  granted.  They  are  in  general 
of  two  kinds.  First,  that  which  permits  a  vacancy  during 
a  (specified  time  while  there  is  a  change  of  tenants,  and 
second,  that  which  permits  an  absence  from  the  property 
by  its  owner.  Whether  the  employment  of  a  caretaker, 
who  daily  or  less  frequently  inspects  the  property, 
operates  to  keep  the  policy  in  force  without  such  a  per- 
mit, has  been  a  subject  for  adjudication. 

Paragraph  (e)  limits  the  liability  of  the  company  for 
certain  well-established  reasons.  The  hazard  at  times 
of  riot  and  war  may  become  much  greater.  It  may  get 
beyond  the  control  of  either  insurer  or  insured.  The 
hazard  is  likely  to  be  beyond  that  contemplated  by  the 
insurer.  The  insured  is  expected  to  use  all  reasonable 
care  to  protect  his  property  at  the  time  of  a  fire  either  in 
the  property  insured  or  when  it  is  exposed.  This  is  in 


THE  POLICY  CONTRACT  159 

harmony  with  the  whole  theory  of  fire  insurance,  which 
is  intended  to  indemnify  property  owners  for  losses 
suffered  beyond  their  control. 

Fire  as  a  consequence  of  lightning  is  usually  covered  by 
the  ordinary  fire  insurance  policy  as  now  written.  The 
company  is  not  liable  for  fire  resulting  as  an  effect  of  the 
collapse  of  the  building,  due  to  an  earthquake,  cyclone, 
or  other  natural  causes.  These  are  neither  a  kind  of 
physical  nor  moral  hazard  which  have  had  consideration 
in  the  establishment  of  the  rate.  There  are  other  policies 
which  grant  insurance  against  some  of  these  occurrences. 

Paragraph  (g)  excepts  certain  articles  from  insurance 
unless  liability  has  been  distinctively  assumed. 

Paragraph  (i)  establishes  the  agency  relationship  in 
order  to  fix  definitely  the  liability  of  the  insurer.  The 
fire  insurance  agent  is  legally  the  representative  of  the 
company  and  binds  the  principal  by  his  acts.  He  has 
much  more  power  than  the  life  insurance  agent.  He 
issues  policies,  and  therefore  the  company  reserves  the 
right  of  deciding  who  shall  be  authorized  to  assume  lia- 
bility for  it. 

Cancellation.  —  Paragraph  (k)  provides  for  cancella- 
tion by  both  parties  to  the  contract.  It  frequently 
happens  that  both  insured  and  insurer  desire  to  do  this. 
The  insured  may  sell  the  property  and  wish  a  return  of 
the  unearned  premium.  The  insurer  may  discover  an 
increase  in  the  moral  hazard  and  desire  to  return  that 
part  of  the  premium  which  it  does  not  wish  to  earn. 

Removal  of  Property.  —  Paragraph  (m)  refers  to  the 
insurance  on  removed  goods.  While  another  clause 
requires  the  insured  to  use  all  reasonable  means  to  save 


i6o  PRINCIPLES  OF  INSURANCE 

the  property  at  the  time  of  a  fire  which  necessitates  a 
change  in  its  location,  yet  a  limit  of  time  is  placed  as  to 
the  duration  of  the  insurance  in  the  new  location.  The 
removal  of  the  property  may  well  have  caused  a  change  in 
the  hazard,  and  it  is  assumed  that  a  period  of  five  days  is 
sufficient  for  the  insured  to  make  provisions  with  the 
insurer  for  a  rate  of  charge  which  will  be  an  expression 
of  the  new  hazard. 

Paragraph  (w)  refers  to  waivers,  permits,  and  other 
exceptions  to  the  body  of  the  contract.  They  must  not 
only  appear  as  a  written  in  or  attached  portion  of  the 
contract,  but  must  also  be  properly  signed  and  accepted 
by  the  company.  Certain  subjects  in  the  policy  may  be 
a  matter  for  waiver ;  others  are  not,  and  the  agent  has 
no  power  to  exceed  his  authority  by  granting  such  per- 
mits. 

The  remainder  of  the  policy  provides  for  the  date  of 
acceptance,  the  signature  of  the  company  and  its  repre- 
sentative. 

Riders.  —  Clauses  in  the  form  of  riders  may  be  at- 
tached for  the  purpose  of  waiving  or  altering  certain 
policy  provisions.  They  frequently  appear  in  the  policy, 
and  in  harmony  with  a  long-accepted  principle  of  law  in 
interpreting  contracts,  anything  written  on  or  attached 
to  the  contract  takes  precedence  over  the  printed  part  of 
the  contract  referring  to  the  same  subject.  It  must  be 
understood,  however,  that  the  agent  must  act  within  the 
limits  of  his  authority,  and  also  that  those  parts  of  the 
policy  which  clearly  set  forth  limitations  and  methods 
of  procedure  do  not  admit  of  alteration.  Whether  an 
agent  acting  "  under  the  color  of  authority  "  may  bind 


THE  POLICY  CONTRACT  161 

the  company,  has  become  at  times  a  matter  for  the  court 
to  decide.  The  discussion  of  the  remaining  portions  of 
the  policy,  which  refer  to  the  settlement  of  the  loss,  is 
deferred  to  later  chapters. 

In  addition  to  the  ordinary  fire  insurance  policy,  there 
are  several  other  forms  or  rather  special  forms  of  this 
standard  policy.  Among  others,  the  following  may  be 
mentioned : 

The  Specific  Policy.  —  The  Specific  Policy,  which  is 
said  to  be  of  specific  coverage,  as  contrasted  with  general 
coverage.  This  policy  protects  property  which  has  a 
definite  location.  It  may  be  property  of  a  single  amount 
at  a  single  point  or  property  of  different  amounts  located 
at  different  specifically  enumerated  locations  with  a 
definite  amount  of  insurance  on  each  part.  A  policy 
with  $10,000  insurance  on  a  building,  or  one  with  $5000 
on  the  building  and  $5000  on  the  contents  or  $2500  on 
each  of  two  buildings  and  $2500  on  the  contents  in  each 
building,  would  be  examples  of  specific  policies. 

The  Blanket  Policy.  —  The  Blanket  Policy  is  one  in 
which  there  is  a  certain  amount  of  insurance  granted, 
which  may  cover  the  building  and  its  contents  or  two  or 
more  buildings  and  their  contents  with  no  specific  dis- 
tribution of  definite  amounts  on  the  buildings  and  the 
stock  of  goods. 

The  Open  Policy.  —  The  Open  Policy  or  Running  Pol- 
icy is  one  which  is  usually  applied  to  merchandise,,  the 
units  and  amounts  of  which  are  continually  changing. 
It  may  be  in  its  application  either  a  specific  or  a  blanket 
policy.  The  rate  of  premium  may  change  with  the 
changing  character  or  quantity  of  the  merchandise.  The 


162  PRINCIPLES  OF  INSURANCE 

stock  of  goods  in  warehouses  is  continually  changing, 
and  this  type  of  policy  does  not  necessitate  the  writing 
of  a  new  policy  with  every  change  in  the  property  to  be 
protected. 

The  Floating  Policy.  —  This  policy  indicates  its  char- 
acter by  its  name.  It  is  used  to  apply  to  goods  whose 
character  and  location  are  continually  changing,  as,  for 
example,  merchandise  in  transit.  Its  terms  are  broad, 
and  its  specific  application  as  to  the  amount  covered  is 
largely  a  matter  for  adjustment  at  the  time  of  a  loss. 

There  are  other  kinds  of  policies  which  protect  property 
against  losses  due  to  other  than  direct  losses  by  fire,  but 
which  indemnify  the  owner  for  losses  indirectly  resulting 
from  the  fire.  The  following  forms  may  be  noted : 

Use  and  Occupancy  Policy.  —  This  type  of  policy 
promises  to  have  more  extensive  application  as  its  ad- 
vantages become  recognized  and  experience  supplies 
more  data  for  its  proper  application.  Its  purpose  may 
be  more  clearly  understood  by  considering  the  situation 
which  confronts  a  producer  when  a  fire  has  occurred 
than  by  attempting  to  define  the  policy.  The  fire  which 
occurs  in  a  plant  may  not  only  destroy  the  physical  plant, 
but  it  interrupts  the  business.  The  product  is  not  sent 
regularly  to  its  purchasers.  Many  expenses,  such  as 
interest  on  the  capital  invested,  many  of  the  ordinary 
expenses,  such  as  wages,  taxes,  and  many  of  the  fixed 
expenses  of  the  business  continue  whether  the  plant  is 
or  is  not  running.  The  owner  is  receiving  no  income 
from  his  business  out  of  which  he  may  pay  these  ex- 
penses. The  period  of  interruption  represents  losses 
other  than  those  due  to  the  destruction  of  the  physical 


THE  POLICY  CONTRACT  163 

property.  Use  and  occupancy  policies  insure  against 
these  losses  arising  from  interrupted  production.  The 
proceeds  of  the  policy  may  be  used  to  lease  another  plant, 
or  rent  another  building,  or  to  purchase  new  machinery 
and  thus  to  supply  customers  more  quickly  with  their 
goods.  Such  a  policy  does  not  of  course  guarantee 
profits  in  the  strict  sense.  It  is  product  rather  than 
profit  which  is  insured. 

These  policies  are  written  with  a  maximum  amount 
which  will  be  paid  and  also  with  a  specified  sum  which 
will  be  paid  per  day  during  the  interruption  of  the  busi- 
ness. Manifestly  great  care  is  exercised  in  deciding  the 
class  of  producers  to  whom  such  a  policy  can  be  granted. 
The  firm  or  individual  must  be  one  of  character  with  a 
secured  business  and  such  organization  of  its  finances  and 
accounting  methods  as  will  make  it  possible  to  arrive  at 
the  real  losses  suffered.  The  amount  of  the  policy  is 
some  percentage  of  the  business  transacted,  10  or  15 
per  cent  being  a  common  percentage  to  insure.  But  the 
character  of  the  plant  and  goods  and  the  rapidity  of  the 
turnover  cause  a  considerable  difference  in  this  amount, 
as  well  as  in  the  rate  at  which  the  risk  is  written.  Pro- 
vision is  often  made  in  these  policies  for  the  change  in  the 
amount  of  products  or  goods  sold,  due  to  fluctuations  in 
business  conditions,  seasonal  demand,  or  weather  condi- 
tions. 

The  Rent  Policy.  —  Rent  Insurance  is  of  comparatively 
recent  development,  but  the  growth  of  cities  and  the  large 
investments  in  renting  properties  promise  an  increasing 
use  of  this  form  of  the  fire  insurance  policy.  This  policy 
is  intended  to  protect  the  owner  of  property  against  the 


i64  PRINCIPLES  OF  INSURANCE 

loss  of  his  rents,  due  to  a  fire.  The  loss  is  based  upon  the 
actual  rent  lost  by  the  fire  and  is  computed  from  the  time 
of  the  fire  to  that  time  in  which  it  would  be  possible  to 
repair  the  property  and  put  it  in  condition  for  inhabiting. 
Usually  the  insured  is  required  to  carry  insurance  on  the 
rents  to  an  amount  equal  to  the  actual  rents  of  the  whole 
property,  and  if  at  the  time  of  the  fire  this  total  insurance 
is  less  than  the  actual  rents,  the  insured  is  held  to  be  an 
insurer  to  the  amount  of  such  deficiency.  He  thus  bears 
his  proportionate  share  of  the  loss ;  that  is,  he  becomes 
a  coinsurer.  Such  policies  have  ordinarily  little  of  the 
moral  hazard  in  them,  since  the  renter  and  not  the  owner 
is  the  occupier.  Rents  are  also  definite  quantities,  and 
the  damage  or  loss  can  easily  be  ascertained.  The 
salvage  is  therefore  likely  to  be  greater  than  in  ordinary 
fire  insurance  policies  on  buildings  and  contents. 

Leasehold  Policy.  —  Leasehold  Insurance  is  a  form  of 
insurance  which  is  designed  to  protect  the  lessee  both  in 
respect  to  his  losses  in  his  sub-leases  and  in  what  he  pays 
the  owner ;  or  it  may  be  used  by  a  person  who  purchases 
land  and  erects  a  building  on  it  for  the  purpose  of  renting. 
Such  policies  are  very  complex,  owing  to  the  great  varia- 
tion in  the  relationship  of  owners  and  occupiers  of  land 
and  buildings  in  the  modern  industrial  city.  The  moral 
hazard  may  be  very  great  in  this  type  of  policy. 

Profit  Policy.  — A  more  recent  kind  of  policy  is  that 
designed  to  insure  the  profits  of  a  business.  Use  and 
occupancy  insurance  is  not  intended  to  cover  profits, 
although  such  insurance  would  not  be  written  by  a  careful 
company  on  a  plant  or  business  which  was  not  making  a 
profit.  It  is  evident  that  a  policy  to  insure  profits  can  be 


THE  POLICY  CONTRACT  165 

written  only  on  individuals  and  firms  of  the  best  character 
and  also  only  when  the  most  complete  and  detailed  facts 
regarding  the  business  are  known.  The  moral  hazard 
in  such  policies  may  become  very  great,  since  if  it  were 
possible  to  guarantee  profits  absolutely,  many  producers 
would  be  quite  willing  to  purchase  insurance  as  the  least 
expensive  means,  both  in  money  outlay  and  efforts,  to 
receive  such  profits. 

All  these  forms  of  policies  —  Use  and  Occupancy, 
Rent,  Leasehold  and  Profit  —  are  closely  related  to  the 
ordinary  fire  policy  which,  it  has  been  shown,  covers  only 
the  losses  due  directly  to  fire. 

Sprinkler  Leakage  Policy.  —  Another  form  of  policy 
is  that  designed  to  protect  against  losses  due  to  the  leak- 
age of  automatic  sprinklers.  These  sprinklers,  as  will 
be  described  later,  are  installed  in  buildings  for  the  pur- 
pose of  extinguishing  a  fire  in  its  early  stages.  In  such 
a  system,  the  valve  may  open  or  a  pipe  may  burst  and 
do  great  damage  to  the  building  or  its  contents.  Any 
damage  done  by  the  water  from  these  pipes  at  the  time  of 
a  fire  is  of  course  covered  by  the  ordinary  fire  policy, 
since  this  is  a  loss  due  directly  to  fire.  The  Sprinkler 
Leakage  Policies  cover  the  damages  due  to  the  unex- 
pected losses  growing  out  of  the  abnormal  operation  of 
the  sprinkler  equipment. 

Tourists''  Policies  and  Common  Carriers'  Liability 
Policies  are  of  many  kinds,  but  are  examples  of  Floaters' 
Policies.  Thus  from  a  relatively  simple  contract  the  fire 
insurance  contract  has  evolved  in  a  truly  evolutionary 
manner  into  highly  complex  and  simple  forms.  That  is 
to  state,  the  fire  insurance  policy  is  being  applied  to  protect 


166  PRINCIPLES  OF  INSURANCE 

against  many  losses  other  than  those  due  directly  to 
fire,  and  at  the  same  time,  there  is  a  growing  uniformity 
and  standardization  in  each  of  the  particular  forms. 
Doubtless  it  will  receive  new  applications  as  new  condi- 
tions arise. 

REFERENCES 

The  Business  of  Insurance,  Vol.  I,  Chap.  IV. 

Yale  Readings  in  Fire  Insurance,  Chap.  IX. 

Lectures  on  Fire  Insurance,  Part  IV. 

Insurance  and  the  State,  Chap.  IV.    W.  F.  Gephart. 

Origin  of  the   Standard   Fire  Insurance  Policy.    An  Address. 

Elijah  R.  Kennedy.     The  Insurance  Society  of  New  York. 
Forms.     From    the    Company's    Standpoint    (Pamphlet).    The 

Insurance  Society  of  New  York. 

Proceedings  of  the  National  Board  of  Underwriters,  1915. 
A  Treatise  on  the  Law  of  Insurance.     George  Richards. 


CHAPTER  VIII 

THE   LOSS   AND   ITS   ADJUSTMENT 

Importance  of  the  Settlement  Clauses.  —  The  settle- 
ment of  the  loss  is  the  test  of  the  policy  contract  both  from 
the  viewpoint  of  the  insured  and  the  insurer.  The  risk 
has  been  assumed  by  the  insurer  for  a  consideration  which 
is  presumed. to  measure  it  correctly,  and  the  insured  has 
given  this  consideration  because  he  expects  to  receive 
full  payment  in  the  event  of  a  loss.  It  is  chiefly  in 
connection  with  this  settlement  of  the  loss  that  disagree- 
ments between  the  parties  to  the  contract  arise.  This 
situation  is  largely  responsible  for  the  numerous  appeals 
to  the  courts  as  a  final  arbiter  of  the  fire  insurance  con- 
tract. The  standard  policies,  therefore,  have  attempted 
to  make  as  explicit  as  possible  each  of  the  provisions  of 
the  contract  which  apply  after  a  loss  has  occurred. 

In  the  previous  chapter,  the  chief  "  conditions  pre- 
cedent "  have  been  stated  and  explained.  The  "  condi- 
tions subsequent  "  are  now  to  be  discussed :  first,  as  to 
what  they  are,  and,  second,  as  to  some  of  the  more  impor- 
tant judicial  interpretations  which  have  been  made  of 
them.  This  second  phase  of  the  subject  is  a  very  large 
and  complex  one,  inasmuch  as  insurance  is  a  subject  for 
regulation  in  each  state.  A  relatively  small  number  of 
the  cases  of  this  character  reach  the  federal  courts.  The 
state  courts  frequently  differ  in  their  application  of  the 

167 


1 68  PRINCIPLES  OF  INSURANCE 

same  principle.  In  other  cases  this  difference  results 
from  a  difference  in  the  laws  of  the  states  on  the  particu- 
lar subject. 

Basis  of  the  Settlement.  -7  In  section  (5)  of  the  policy 
the  basis  of  the  loss  settlement  is  stated  to  be  the  actual 
cash  value  of  the  property  at  the  time  of  the  fire  or  the 
damage  which  has  been  done  to  it  less  any  depreciation 
which  has  occurred.  This  cash  value  is  based  upon  its 
cost  value  to  the  insured  and  not  its  selling  value.  Other 
forms  of  insurance  such  as  Use  and  Occupancy  and 
Profit  Insurance  protect  the  insured  in  other  respects. 
The  ordinary  direct-loss  fire  insurance  policy  is  indemnity 
for  property  destroyed,  not  for  anticipated  profits  to  be 
derived  from  its  continued  use  and  sale.  When  the  loss 
occurs,  the  insurer  may  make  settlement  by  either  one  of 
two  means.  He  may  pay  the  monetary  value  to  the 
insured  or  he  may  "  repair,  rebuild  or  replace  the  property 
lost  or  damaged  with  others  of  like  kind  and  quantity." 
This  second  option  is  not  frequently  used,  first,  because 
the  insurance  company  is  not  a  producer  of  goods  nor  is  it 
organized  to  deal  in  goods  and  materials ;  and,  second, 
because  there  exists  a  large  opportunity  for  difference  of 
opinion  as  to  what  would  be  "  property  of  like  kind  and 
quality."  In  some  cases  companies  have  chosen  to  avail 
themselves  of  this  option  and  later  have  found  that  the 
judicial  opinion  did  not  agree  with  their  action.  The 
result  was  that  the  insured  became  possessed  of  the 
replaced  property  and  also  was  permitted  to  secure  the 
monetary  value  of  the  destroyed  property. 

Time  Limit  for  Settlement.  —  The  period  established 
for  the  payment  of  the  loss  is  sixty  days  "  after  due  notice, 


THE  LOSS  AND   ITS  ADJUSTMENT         169 

ascertainment,  estimate,  and  satisfactory  proof  of  the 
loss. ' '  This  is  to  afford  a  sufficient  period  for  determining 
the  loss.  As  a  matter  of  practice  many  claims  are  paid 
within  this  period,  while  others  are"  paid  long  after  this 
period.  The  policy  states  that  the  loss  is  payable  sixty 
days  after  this  proof  and  not  that  it  must  be  paid  at  that 
particular  date. 

Clause  (/)  states  that  no  claim  can  be  made  before  the 
above  conditions  have  been  met,  and  further,  that  any 
suit  or  action  on  the  policy  cannot  be  instituted  unless 
it  has  been  entered  within  twelve  months  next  after 
the  fire.  This  is  for  the  purpose  of  facilitating  loss  settle- 
ments, for  it  is  to  the  interest  of  both  parties  that  the 
claims  be  settled  as  quickly  as  possible.  The  insured 
should  be  paid  the  claim  to  enable  him  to  rebuild  or  to 
restore  his  property,  and  the  insurer  is  interested  in  hav- 
ing the  claim  made  immediately  after  the  fire  when  the 
condition  of  the  property  and  other  facts  in  connection 
with  it  can  most  easily  and  completely  be  known.  The 
courts  have  been  liberal  in  applying  this  part  of  the  con- 
tract, especially  in  those  cases  where  no  evidence  of  fraud 
or  undue  negligence  was  shown  on  the  part  of  the  insured. 
The  insurance  contract  has  been  made  by  the  insurer,  and 
it  is  generally  interpreted  and  applied  in  the  interests  of 
the  insured.  Every  reasonable  and  fair  means  will  be 
used  to  aid  the  insured  in  collecting  his  claim. 

Conditions  Subsequent  to  Settlement  of  a  Claim.  —  In 
enforcing  this  liability  on  the  insurer,  there  are,  however, 
enumerated  steps  in  the  procedure  which  are  set  forth  in 
the  policy.  These  are  required  on  the  part  of  the  insured 
and  constitute  the  chief  "  conditions  subsequent  "  to  the 


170  PRINCIPLES  OF  INSURANCE 

collection  of  the  claim.  In  the  first  place,  clause  (e) 
prohibits  any  abandonment  of  the  property  by  the 
insured.  He  must  use  all  reasonable  means  to  protect 
and  preserve  the  property.  In  clause  (m)  it  is  provided 
that  when  in  the  fulfillment  of  this  requirement  the 
property  is  removed  to  a  place  of  safety,  the  insurance 
is  extended  to  cover  the  property  in  its  new  location  for  a 
minimum  period. 

In  the  second  place  the  insured  is  required  in  clause  (n) 
to  protect  the  property  from  further  loss.  He  must 
notify  the  company,  which  usually  takes  the  form  of 
notifying  the  agent  of  the  company,  that  a  loss  has  been 
suffered.  He  then  makes  out  a  loss  statement,  and 
supplies  the  company  with  other  information,  such  as 
the  cause  and  the  time  of  the  fire,  his  interest  in  the 
property,  the  debts  upon  it,  the  amount  of  other  in- 
surance upon  it,  any  change  in  occupancy  or  ownership 
since  the  contract  was  made,  and  much  other  detailed 
information. 

Disagreement  as  to  Loss.  —  It  is  in  connection  with 
the  loss  statement  as  to  value  of  property  and  goods  that 
disagreements  arise  between  the  insured  and  the  insurer. 
These  differences  often  result  from  honest  difference  of 
opinion ;  at  other  times  because  the  insured  has  no  data 
upon  which  to  make  an  accurate  loss  statement ;  and  at 
other  times  through  dishonesty  of  one  of  the  parties  in 
an  effort  either  to  collect  more  insurance  than  the  actual 
loss  or  to  escape  the  payment  of  a  just  claim.  The  loss 
or  damage  to  the  building  is  a  physical  fact  and  is  often 
easier  to  determine  than  the  loss  on  the  goods  or  contents. 
But  even  in  the  case  of  a  building  loss  which  is  partial, 


TIJE  LOSS   AND   ITS  ADJUSTMENT         171 

difficulties  arise.  The  stone  facing  may  have  spalled 
as  a  result  of  the  fire  without  in  any  way  weakening  the 
wall.  It  may  be  repaired  at  a  small  expense,  but  the  in- 
sured may  wish  to  claim  a  complete  loss.  The  insured 
at  the  time  of  the  fire  is  disposed  to  magnify  his  loss, 
however  honest  he  may  be,  due  to  the  fact  of  the  sudden 
and  impressive  character  of  the  loss.  A  gradual  loss,  as, 
for  example,  a  decrease  in  his  business,  would  not  loom  so 
large  in  his  mind.  However  numerous  the  opportunities 
for  disagreement  in  the  case  of  building  losses,  the  diffi- 
culty of  arriving  at  a  fair  settlement  of  the  loss  on  con- 
tents may  be  much  greater.  The  insured  is  often  unable 
to  supply  documentary  evidence  of  his  loss  in  the  form 
of  accounting  records,  bills  of  invoice,  and  other  similar 
evidence.  These  may  have  been  destroyed  in  the  fire, 
or  the  insured  may  have  kept  no  such  complete  record. 
The  property  is  often  destroyed  so  completely  that  no 
evidence  of  value  can  be  secured.  The  insured  is  in  the 
position  of  advantage,  since  he  usually  knows  what  his 
probable  losses  are.  His  statements  may  in  some  cases 
be  verified  by  the  records  of  those  who  sold  the  goods  to 
him,  but  even  then  the  amount  of  the  goods  which  have 
been  sold  as  compared  to  the  quantity  which  has  been 
purchased  is  a  fact  known  only  to  the  insured,  if  known 
to  any  one.  The  moral  hazard  may  therefore  be  very 
great.  The  only  question  to  be  answered  for  the  purpose 
of  setting  the  loss  is  what  was  the  value  of  the  goods  at 
the  time  of  the  fire.  The  loss  on  goods  may  be,  accord- 
ing to  the  common  classification,  "  trifling,"  "  slight," 
"  considerable,"  or  "  total,"  and  in  this  classification 
there  is  great  opportunity  for  difference  of  opinion. 


I72  PRINCIPLES  OF  INSURANCE 

Methods  of  Determining  the  Loss.  —  In  arriving  at  the 
actual  sum  to  be  paid  for  contents  there  are  three  methods 
provided  in  the  standard  policy :  (a)  agreement,  (&)  ap- 
praisal, and  (c)  the  acquirement  by  the  insurer  of  the 
stocks  of  goods  at  their  appraised  value.  In  the  settle- 
ment of  a  loss,  either  on  a  building  or  its  contents,  the 
work  of  the  adjuster  is  important.  The  adjuster  may  be 
a  person  who  does  this  work  as  a  regular  business.  He  is 
not  the  employee  of  any  company,  but  sells  his  service 
either  to  the  insurer,  or  in  some  cases,  when  large  property 
values  are  concerned,  he  undertakes  the  settlement  of  the 
loss  for  the  insured.  The  adjuster  is,  however,  more 
usually  a  representative  of  the  insurance  company. 
There  are  adjustment  bureaus,  organized,  owned,  and 
operated  by  the  companies,  located  in  the  largest  cities 
with  branches  in  the  smaller  cities.  Since  several  com- 
panies are  usually  represented  on  any  considerable  loss, 
each  of  the  companies  may  agree  upon  one  adjuster  to 
represent  them  and  thus  save  unnecessary  outlays  in 
settling  the  loss.  In  the  smaller  cities  and  in  the  rural 
districts  the  adjustment  of  losses  is  usually  made  by 
the  regular  agents  of  the  insurance  companies.  An 
agreement  is  often  made  between  the  insured  and  the 
adjuster,  either  as  agent  or  professional  adjuster,  for  the 
settlement  of  the  loss.  This  agreement  may  be  reduced 
to  writing  or  it  may  be  oral.  In  the  case  of  large  losses 
it  should  always  be  a  written  agreement,  signed  by  the 
insured  and  the  insurer  or  their  authorized  representa- 
tives. In  the  case  of  minor  losses  or  in  the  case  of  com- 
plete losses  which  do  not  involve  large  sums  such  an 
agreement  is  frequently  easy  to  secure.  In  so  far  as  a 


THE  LOSS  AND   ITS  ADJUSTMENT         173 

complete  record  of  specific  losses  can  be  furnished  by 
the  insured,  the  chances  of  reaching  an  agreement  with 
the  adjuster  are  increased.  Book  statements,  invoices, 
bills  of  lading,  and  other  evidences  of  loss  are  examined. 
Compromises  are  reached.  Experts  may  be  called  in  to 
pass  upon  values. 

The  Appraiser.  —  If,  however,  an  agreement  cannot 
be  reached  between  the  insured  and  the  adjuster,  the 
standard  policy  provides  in  clause  (p)  for  the  selection 
of  an  appraiser  by  the  insured  and  the  insurer.  These 
two  disinterested  appraisers  select  a  disinterested  umpire. 
In  some  cases  difficulty  arises  in  this  connection  with 
respect  to  the  fact  of  competency  and  disinterestedness 
of  both  appraisers  and  umpire.  The  insured  may  select 
an  appraiser  whom  the  insurer  does  not  consider  proper, 
either  because  he  does  not  know  the  property,  or  because 
the  insured  wishes  to  have  "  a  friend  at  court  "  in  the  per- 
son of  an  interested  appraiser ;  or  the  insured  may  think 
the  appraiser  selected  by  the  insurer  is  chiefly  interested 
in  an  effort  to  see  how  well  he  can  protect  the  company 
from  paying  the  loss;  or  the  two  appraisers  may  have 
difficulty  in  selecting  an  umpire,  since  in  actual  practice 
this  umpire  must  be  satisfactory  to  the  insured  and  the 
insurer  and  not  primarily  to  the  appraisers.  The  ap- 
praisers continue  their  work  of  arriving  at  the  value  of 
the  property  after  this  umpire  is  selected,  and  when  dis- 
agreement arises,  the  decision  of  the  umpire  and  either 
appraiser  is  binding.  When  the  actual  amount  of  the 
loss  has  been  determined,  the  question  may  then  arise  of 
its  distribution.  This  requires  an  examination  of  the 
terms  of  the  contract  with  respect  to  the  distribution 


174  PRINCIPLES  OF  INSURANCE 

clauses,  such  as  the  average  clauses,  the  three-fourths  loss 
clause,  the  three-fourths  value  clause,  the  co-insurance 
clause,  as  well  as  an  examination  of  the  laws  of  the  state 
in  respect  to  valued  policy  laws.  Other  questions,  such  as 
the  existence  and  validity  of  other  insurance,  the  evidence 
of  fraud,  arson,  incendiarism,  and  the  interests  of  mort- 
gagees, may  also  arise.  The  limitation  of  liability  and  the 
mortgage  are  discussed  in  the  succeeding  chapter. 

Subrogation.  —  If  the  loss  has  been  determined  to  the 
satisfaction  of  the  insured  and  the  insurer  and  has  been 
paid,  a  right  of  recovery  in  favor  of  the  insurer  against  a 
third  party  may  exist.  This  is  known  as  subrogation  and 
is  provided  for  in  clause  (s)  of  the  policy.  It  is  there 
stated  that  if  the  fire  was  caused  by  an  act  or  the  neglect 
of  any  person  or  corporation,  private  or  public,  the  com- 
pany shall  have  the  right  to  recover  the  amount  which 
has  been  paid  to  the  insured.  The  right  of  such  recovery 
is  to  be  assigned  to  the  insurer  by  the  insured  at  the  time 
of  the  payment  of  the  loss.  This  is  an  important  clause 
and  has  been  a  subject  which  has  caused  much  litigation 
with  variation  in  the  practices  of  courts  in  different  states 
and  countries.  It  is  affected  both  by  the  common  law 
principles  and  by  the  statutory  enactments,  creating  or 
limiting  liability. 

The  doctrine  of  indemnity  is  the  basis  of  this  right  of 
subrogation ;  that  is,  a  person  who  causes  by  overt  act 
or  negligence  a  loss  to  another  is  liable  for  the  damages 
suffered.  The  Supreme  Court  of  the  United  States  has 
stated : 

"In  fire  insurance,  the  insurer,  upon  paying  to  the  assured  the 
amount  of  a  loss  of  the  property  insured,  is  doubtless  subrogated 


THE  LOSS  AND   ITS  ADJUSTMENT         175 

in  a  corresponding  amount  to  the  assured's  right  of  action  against 
any  other  person  responsible  for  the  loss.  But  the  right  of  the 
insurer  against  such  other  person  does  not  rest  upon  any  other 
relation  of  contract  or  of  priority  between  them.  It  arises  out 
of  the  nature  of  the  contract  of  insurance  as  a  contract  of  indem- 
nity and  is  derived  from  the  assured  alone  and  can  be  enforced  in 
his  right  only.  By  the  strict  rules  of  the  common  law,  it  must  be 
asserted  in  the  name  of  the  assured.  ...  In  any  form  of  remedy 
the  insurer  can  take  nothing  by  subrogation  but  the  rights  of  the 
assured,  and  if  the  assured  has  no  right  of  action,  none  passes  to 
the  insurer"  [St.  Louis  I.  M.  &  S.  Ry.  Co.  v.  Commercial  Union 
Insurance  Co.,' 139  U.  S.  223]. 

The  chief  points  herein  made  are  that  in  this  respect 
subrogation  is  a  common-law  right ;  it  is  a  right  of  the 
insured,  and  that  the  insurance  contract  is  one  of  in- 
demnity. In  respect  to  this  last  point,  the  courts  have 
not  all  been  uniform  in  their  decision,  although  the  weight 
of  authority  is  decidedly  in  harmony  with  this  view. 

Subrogation  frequently  arises  in  connection  with  in- 
surance contracts,  not  only  in  fire  policies,  but  in  life, 
accident,  and  other  forms  of  policies.  The  question  often 
arises  in  connection  with  the  payment  of  premiums.  An 
individual  may  pay  a  premium  on  a  policy  of  another 
person,  resting  upon  the  right  of  subrogation  for  reim- 
bursement. The  general  rule  is  that  no  one  who  is  not 
in  the  position  of  a  creditor  or  legal  representative  of  the 
insured  has  any  right  of  recovery  under  the  principle  of 
subrogation.  It  has  been  held  that  when  one  satisfies 
an  obligation  against  a  property  against  which  he  has  a 
claim  under  the  honest  belief  that  it  is  necessary  for  him 
to  do  so  in  order  to  protect  his  interest,  the  right  of  sub- 
rogation may  be  permitted. 


176  PRINCIPLES  OF  INSURANCE 

Assigning  Right  of  Subrogation.  —  Since  the  right 
of  subrogation  is  one  belonging  to  the  insured,  it  may  be 
transferred  to  another  person  by  contract.  This  is  what 
occurs  in  the  standard  policy ;  that  is,  the  right  of  the 
insured  is  transferred  to  the  insurer  upon  the  receipt  of 
the  payment  for  the  loss.  This  liability  for  damages  or 
recovery  due  to  a  loss  may  be  created  by  law  without  any 
question  of  neglect  being  taken  into  consideration. 
Transportation  companies  are  commonly  made  liable 
for  loss  or  damages  to  goods  or  persons  conveyed.  This 
has  been  the  cause  of  litigation  at  times  when,  for  ex- 
ample, the  insured  has  contracted  with  the  common 
carrier  that  the  latter  shall  have  the  benefit  of  any  in- 
surance paid  to  the  insured.  If  the  policy  contract  has 
no  clause  of  subrogation  in  which  this  right  of  recovery 
of  the  insured  against  a  third  party  specifically  provides 
for  its  assignment  to  the  insurer,  the  insurer  is  ordinarily 
precluded  from  recovery  in  the  face  of  this  specific  limita- 
tion by  the  insured  of  his  right  of  recovery.  The  Supreme 
Court  has  said  [Phoenix  Insurance  Company  v.  Erie 
Transportation  Co.,  117  U.  S.  312] : 

"That  the  right  of  the  assured  to  recover  damages  against  a 
third  person  is  not  incident  to  the  property  in  the  thing  insured, 
but  only  a  personal  right  of  the  assured,  is  clearly  shown  by  the 
fact  that  the  insurer  acquires  a  beneficial  interest  in  the  right  of 
action,  in  proportion  to  the  sum  paid  by  him,  not  only  in  the  case 
of  a  total  loss,  but  likewise  in  the  case  of  a  partial  loss,  and  when  no 
interest  in  the  property  is  abandoned  or  accrues  to  him. 

"The  right  of  action  against  another  person,  the  equitable  in- 
terest in  which  passes  to  the  insurer  being  only  that  which  the 
assured  has,  it  follows  that  if  the  assured  has  no  such  right  of  action, 
none  passes  to  the  insurer ;  and  that  if  the  assured's  right  of  action 


THE  LOSS  AND  ITS  ADJUSTMENT         177 

is  limited  or  restricted  by  lawful  contract  between  him  and  the  per- 
son sought  to  be  made  responsible  for  the  loss,  a  suit  by  the  in- 
surer, in  the  right  of  the  assured,  is  subject  to  like  limitations  or 
restrictions. 

"For  instance,  if  two  ships,  owned  by  the  same  person,  come 
into  collision  by  the  fault  of  the  master  and  crew  of  the  one  ship 
and  to  the  injury  of  the  other,  an  underwriter  who  has  insured  the 
injured  ship,  and  received  an  abandonment  from  the  owner,  and 
paid  him  the  amount  of  the  insurance  as  and  for  a  total  loss,  ac- 
quires thereby  no  right  to  recover  against  the  other  ship,  because 
the  assured,  the  owner  of  both  ships,  could  not  sue  himself." 

If,  however,  the  policy  contract  has  a  subrogation 
clause  providing  that  the  insurer  shall  upon  payment  of 
the  claim  become  possessed  of  the  rights  of  recovery  of 
the  insured,  and  the  insured,  notwithstanding  this  provi- 
sion in  the  policy,  contracts  with  a  third  party  to  give 
up  his  right  of  recovery,  such  a  contract  will  not  be  held 
to  impair  the  insurer's  right  under  the  preceding  contract. 
The  insurer  may  by  this  act  forfeit  all  his  right  of  recov- 
ery. For  example,  a  rate  upon  the  carriage  of  goods  is 
frequently  determined  in  part  by  the  risk  assumed.  If 
the  shipper  wishes  to  secure  a  lower  rate,  he  may  be 
willing  to  relieve  the  carrier  of  liability  for  loss  and  dam- 
age in  order  to  secure  his  lower  rate.  If  the  policy  of 
insurance  contains  a  subrogation  clause  which  gives  to 
the  insurer  the  insured 's  right  of  recovery,  and  voids 
the  policy  in  the  event  that  any  restriction  is  placed 
upon  this  right,  the  insured  is  left  without  any  right  to 
recover  from  the  insurer  although  it  has  been  held  by  the 
Supreme  Court  of  the  United  States  [Inman  z>.  South 
Carolina  R.  Co.,  129  U.  S.  128]  that  the  right  of  recovery 
still  exists  against  the  railway  company.  The  situation 


178  PRINCIPLES  OF  INSURANCE 

may  arise  where  the  insured  might  be  paid  by  the  insur- 
ance company  a  certain  sum  and  then  under  his  right  of 
recovery  under  the  common  law  secure  a  sum  from  a 
third  party,  the  two  sums  being  together  in  excess  of  the 
value  of  the  property  destroyed.  Thus  arise  the  two 
doctrines  of  indemnity  and  subrogation  and  the  courts 
differ  somewhat  in  the  extent  to  which  they  apply  these 
two  principles  when  they  are  in  conflict.  If,  as  in  the 
case  of  the  Supreme  Court  of  the  United  States  and  some 
of  the  State  Supreme  Courts,  the  insurance  contract  is 
applied  as  one  of  strict  indemnity,  the  insured  is  not 
permitted  to  recover  any  sum  in  excess  of  the  actual  loss. 
The  insurer  under  this  interpretation  will  always  have 
the  right  to  recover  from  the  insured  any  sum  which  he 
receives  that  is  in  excess  of  the  actual  loss  suffered. 

Is  the  Contract  One  of  Indemnity?  —  The  arguments 
for  considering  the  contract  of  insurance  not  one  of  strict 
indemnity  were  stated  in  a  particular  circumstance  by  the 
Massachusetts  Court  [King  v.  The  State  Mutual  Fire 
Insurance  Company,  61  Mass.  7  Gushing  i]  when  it  said : 

"The  case  supposed  is  this :  A  man  makes  a  loan  of  money  and 
takes  a  bond  and  mortgage  for  security.  Say  the  loan  is  for  ten 
years.  He  gets  insurance  on  his  own  interest.  At  the  expiration 
of  seven  years  the  buildings  are  burnt  down.  He  claims  and  re- 
covers a  loss  to  the  amount  insured,  being  equal  to  the  greater 
part  of  his  debt.  He  afterwards  receives  the  amount  of  his  debt 
from  the  mortgagor  and  discharges  his  mortgage.  Has  he  received 
a  double  satisfaction  for  one  and  the  same  debt  ?  He  surely  may 
recover  of  the  mortgagor  because  he  is  a  debtor,  and  on  good  con- 
sideration has  contracted  to  pay.  The  money  received  from  the 
underwriters  was  not  a  payment  of  a  debt ;  there  was  no  priority 
between  the  mortgagor  and  the  underwriters  ;  he  had  not  con- 


THE  LOSS   AND  ITS  ADJUSTMENT         179 

traded  with  them  to  pay  it  for  him  on  any  contingency  ;  he  had 
paid  them  nothing  for  so  doing.  They  did  not  pay  because  the 
mortgagor  owed  it,  but  because  they  had  bound  themselves,  in 
the  event  which  has  happened,  to  pay  a  certain  sum  to  the  mort- 
gagee. 

"  But  the  mortgagee,  when  he  claims  of  the  underwriters,  does 
not  claim  the  same  debt ;  he  claims  a  sum  of  money  due  to  him 
upon  a  distinct  and  independent  contract,  upon  a  consideration 
paid  by  himself  that,  upon  a  certain  event,  to  wit,  the  burning  of  a 
particular  house,  they  will  pay  him  a  sum  of  money  expressed. 
Taking  the  risk  or  remoteness  of  the  contingency  into  considera- 
tion (in  other  words,  the  computed  chances  of  loss),  the  premium 
paid  and  the  sum  to  be  received  are  intended  to  be,  and  in  theory  of 
law  are,  precisely  equivalent.  He  then  pays  the  whole  considera- 
tion for  a  contract  made  without  fraud  or  imposition ;  the  terms 
are  equal,  and  precisely  understood  by  both  parties.  It  is  in  no 
sense  the  same  debt.  It  is  another  and  distinct  debt,  arising  on  a 
distinct  contract,  made  with  another  party,  upon  a  separate  and 
distinct  consideration  paid  by  himself.  The  argument  opposed 
to  this  view  seems  to  assume  that  it  would  be  inequitable,  be- 
cause the  creditor  seems  to  be  getting  a  large  sum  for  a  very  small 
one.  This  may  be  true  of  any  insurance.  A  man  gets  $1000 
insured  for  $5,  for  one  year,  and  the  building  is  burnt  within  the 
year ;  he  gets  $1000  for  $5.  This  is  because,  by  experience  and 
computation,  it  is  found  that  the  chances  are  only  one  in  two  hun- 
dred that  the  house  will  be  burnt  in  any  one  year,  and  the  premium 
is  equal  to  the  chance  of  loss.  But  suppose  —  for  in  order  to  test 
a  principle  we  must  put  a  strong  case  —  suppose  the  debt  has  been 
running  twenty  years,  and  the  premium  is  at  five  per  cent,  the 
creditor  may  pay  a  sum  equal  to  the  whole  debt  in  premiums  and 
yet  never  receive  a  dollar  of  it  from  either  of  the  other  parties. 
Not  from  the  underwriters,  for  the  contingency  has  not  happened, 
and  there  has  been  no  loss  by  fire ;  nor  from  the  debtor,  because, 
not  having  authorized  the  insurance  at  his  expense,  he  is  not  liable 
for  the  premiums  paid. 

"  What,  then,  is  there  inequitable,  on  the  part  of  the  mortgagee, 


i8o  PRINCIPLES  OF  INSURANCE 

towards  either  party,  in  holding  both  sums?  They  are  both  due 
upon  valid  contracts  with  him,  made  upon  adequate  considerations 
paid  by  himself.  There  is  nothing  inequitable  to  the  debtor,  for 
he  pays  no  more  than  he  originally  received,  in  money  loaned  ;  nor 
to  the  underwriter,  for  he  has  only  paid  upon  a  risk  voluntarily 
taken,  for  which  he  was  paid  by  the  mortgagee  a  full  and  satis- 
factory equivalent." 

It  may  be  questioned  whether  the  reasoning  in  this 
case  is  either  an  expression  of  correct  insurance  theory  or 
good  public  policy.  The  premium  in  insurance  is  not 
intended  to  be  and  in  theory  is  not  precisely  equivalent 
to  the  sum  insured.  Premiums  do  pay  losses,  but  it  is 
more  true  to  state  that  past  and  present  premiums  pay 
the  present  losses.  Insurance  theory  in  any  branch  can- 
not be  understood  from  the  individual  standpoint,  for 
insurance  concerns  itself  with  what  happens  to  the  group, 
not  to  the  individual.  Insurance  is  not  an  investment 
in  its  proper  sense  for  any  individual.  All  its  important 
principles  which  determine  the  payment  which  each 
insurer  is  to  pay,  are  based  upon  factors  and  phenomena 
over  which  the  individual  as  such  is  not  presumed  to  have 
any  control.  If  the  individuals  who  are  insured  can  by 
overt  acts  affect  or  determine  the  amount  which  is  to  be 
paid  to  them  from  the  common-fund,  this  invalidates  all 
the  calculations.  The  motives  of  men  and  the  results  of 
their  future  actions  do  not  lend  themselves  to  calculations 
or  predictions  which  can  be  expressed  in  monetary  units. 

The  calculations  of  insurance  premiums  do  not  include 
this  kind  of  personal  factor.  Carelessness  in  the  use  of 
property  may  be  penalized  by  a  higher  rate.  Evidence 
of  dishonesty  and  moral  hazard  of  a  personal  character 


THE  LOSS   AND   ITS  ADJUSTMENT         181 

may  result  in  a  cancellation  of  the  policy.  Insurance  is 
not  a  gross  quantity  which  can  be  purchased  at  so  much 
per  unit,  as  in  the  case  of  ordinary  products. 

In  the  second  place,  this  court  opinion  is  opposed  to  the 
promotion  and  protection  of  public  policy  by  the  insur- 
ance contract.  Insurance  is  not  a  matter  in  which  indi- 
viduals should  be  permitted  to  contract  freely.  No  one 
of  the  insured  group  should  be  permitted  to  secure  a 
gain  from  the  insurance  contract,  for  this  is  opposed  to  the 
spirit  of  insurance,  which  is  but  an  association  of  indi- 
viduals formed  to  share  each  other's  losses.  Any  gain  or 
profit  secured  by  one  member  of  the  group  is  obtained  at 
the  expense  of  the  other  members.  This  is  a  condition 
which  insurance  does  not  contemplate.  It  prostitutes 
insurance  into  a  wager  or  a  gamble  whereby  the  payment 
of  a  small  sum,  as  in  the  case  of  the  mortgagee  in  the 
quoted  decision,  makes  it  possible  to  obtain  a  large  sum 
which  is  in  excess  of  any  real  loss  that  he  has  suffered. 

The  fire  insurance  policy  is  one  of  indemnity,  and  in 
order  to  guard  against  any  other  application  of  the 
contract,  the  policy  should  contain  a  definite  provision 
whereby  neither  the  insured,  mortgagee,  nor  another 
having  an  insurable  interest  in  the  property  can  recover 
more  than  the  property  value  actually  lost. 

The  subrogation  clause  is  therefore  of  greatest  impor- 
tance in  making  in  actual  practice  the  insurance  policy 
one  of  strict  indemnity.  Notwithstanding  the  difference 
among  courts  in  applying  this  principle  of  subrogation, 
there  is  an  increasing  tendency  to  apply  it  in  a  manner 
to  secure  the  application  of  this  indemnity  principle. 
The  peculiar  circumstances  and  facts  of  each  case 
determine  the  character  of  its  application. 


i82  PRINCIPLES  OF  INSURANCE 

REFERENCES 

The  Adjustment  of  Building  Losses.    William  R.  Freeman. 
The  Adjustment  of  Stock  Losses.     Donald  C.  Brown. 
Ascertainment  of  Value  and  Profits  from  Books  of  Account. 

James  A.  McKenna. 

Subrogation.    William  H.  Van  Beuschoten. 
Four  Addresses  before  the  Insurance  Society  of  New  York. 
The  Business  of  Insurance,  Vol.  I,  Chap.  VI. 
Handbooks  of  Fire  Insurance. 
Adjustments.    Thrasher  Hull. 
Fire  Loss  Settlements  and   the  Conditions  of  Fire  Insurance 

Policies.     Thomas  J.  Milner. 
A  Treatise  on  the  Law  of  Insurance.    George  Richards. 


CHAPTER  IX 

LIMITATION   OF   LIABILITY   AND   DISTRIBUTION 

IN  addition  to  the  ordinary  clauses  in  a  fire  insurance 
policy  which  limit  the  liability  of  the  company,  there 
are  other  special  clauses  more  definitely  limiting  the 
liability,  either  on  account  of  the  particular  character 
of  the  property  insured  or  because  of  a  desire  to  assess 
the  fire  insurance  charge  equitably  among  the  insured. 
No  other  clauses  have  occasioned  so  much  discussion 
and  criticism  and  led  to  so  much  legislation  which  has 
prevented  a  fair  distribution  of  fire  insurance  cost. 

Specific  Clauses  Limiting  Liability.  —  The  most  im- 
portant clauses  of  this  description  are  the  Three-fourth 
Value  Clause,  the  Three-fourth  Loss  Clause,  the  Average 
Clause,  and  the  Coinsurance  Clause.  It  will  aid  in  an 
understanding  of  the  purpose  of  these  clauses  and  the 
discussion  of  Valued-policy  Laws,  Mortgage  Clauses, 
and  Insurable  Interests  which  follow,  if  the  character- 
istics of  the  fire  insurance  rate  are  recalled.  While 
the  rate  is  not  exactly  synonymous  to  an  ordinary  tax, 
as  fire  insurance  officials  frequently  argue,  yet  its  simi- 
larity to  a  tax  is  greatest  in  connection  with  these 
clauses  and  the  laws  which  have  resulted  from  the  effort 
of  insurance  companies  to  incorporate  them  in  the 
policies.  That  is  to  say,  the  loss  by  fire  represents  so 

183 


184  PRINCIPLES  OF  INSURANCE 

many  dollars  of  property  value  which  must  be  contrib- 
uted by  those  property  owners  who  have  insured  prop- 
erty. The  amount  of  revenue  demanded  by  the  gov- 
ernment represents  so  much  money  which  must  be 
contributed  by  the  owners  of  wealth  of  a  taxable  char- 
acter. Assume  that  the  general  rule  of  collecting  this 
tax  is,  that  each  should  pay  on  the  basis  of  what  he  has 
and  on  its  full  or  a  certain  uniform  value;  so  the  in- 
sured should  contribute  his  insurance  tax  on  a  basis  of 
the  protection  he  secures,  the  cost  of  which  or  the  rate 
being  determined  by  the  hazard  of  his  risk  and  the 
amount  of  the  risk.  Any  excess  protection  that  he 
secures,  or  any  sum  paid  to  hifn  over  and  above  his 
actual  loss,  comes  from  this  general  fund  and  represents 
an  unwilling  gift  from  the  other  insured  members.  The 
fire  loss  must  be  met  and  the  insured  meet  it  by  the 
payments  of  premiums.  Any  one  member  secures  this 
protection  only  by  the  existence  of  many  members,  and 
any  deficient  payment  by  one,  means  an  excess  payment 
by  another  or  by  a  class.  This  results  in  a  discrimina- 
tion in  the  charge. 

The  Three-fourth  Value  Clause.  —  The  Three-fourth 
Value  Clause  is  one  which  provides  that  in  the  event  of 
a  loss  the  company  is  liable  to  an  amount  not  to  exceed 
three  fourths  of  the  actual  cash  value  of  the  property, 
and  if  other  policies  are  in  existence,  then  for  only  its 
pro  rata  share  of  this  value.  The  prime  purpose  of 
this  clause  is  to  prevent  overinsurance,  just  as  the 
coinsurance  clause  is  intended  to  encourage  a  reasonable 
amount  of  insurance.  It  may  be  thought  that  no  prop- 
erty owner  would  be  willing  to  pay  in  premiums  a  sum 


LIMITATION  OF  LIABILITY  185 

of  money  in  excess  of  what  was  necessary  to  secure 
adequate  protection  for  his  property.  But  when  it  is 
remembered  that  the  premium  is  a  comparatively 
insignificant  sum  in  respect  to  the  total  value  of  the 
property,  especially  when  the  policy  is  taken  for  a  short 
period,  such  as  a  year  or  less,  and  especially  that  the 
amount  in  excess  of  the  premium  necessary  to  secure 
full  protection  is  small,  the  disposition  to  overinsurance 
does  not  seem  to  be  so  unexplainable.  Nor  does  this 
disposition  to  overinsure  always  represent  a  conscious 
desire  to  defraud  the  company  and  other  policyholders. 
After  making  all  due  allowances  for  the  deliberate  acts 
of  overinsuring  for  the  purpose  of  gain,  there  still  remain 
conditions  under  which  there  is  a  natural  tendency  in 
this  direction. 

The  owners  of  unprotected  property,  that  is,  property 
in  rural  districts  and  villages  where  there  is  an  absence 
of  fire  and  water  departments,  are  frequently  disposed 
to  take  out  insurance  in  excess  of  the  full  value  of  the 
property.  This  may  be  due  in  part  to  the  fact  that  a 
loss  to  such  owners  would  often  be  very  serious.  Be- 
cause of  this  direct  personal  result  they  are  willing  to 
pay  the  increased  amount  for  surplus  insurance.  Such 
owners  are  not  usually  guilty  of  any  conscious  wrong 
conduct.  They  and  others  who  overinsure  think  of 
insurance  as  a  thing  that  is  sold  in  quantity  at  so  much 
per  $100 ;  or  in  other  words,  that  they  can  buy  the  right 
to  receive  so  many  dollars  of  insurance  by  the  payment 
of  a  certain  rate  per  unit  of  the  insurance.  They  seldom 
think  of  the  rate  and  amount  of  insurance  as  being 
determined  by  their  property,  its  condition,  and  use. 


i86  PRINCIPLES  OF  INSURANCE 

The  company  is  considered  as  the  source  of  supply. 
It  is  farthest  from  their  minds  that  they  themselves 
have  a  monopoly  of  the  supply.  Whether  this  over- 
insurance  results  from  the  preceding  mistaken  but  not 
criminal  notions,  or  whether  it  is  a  result  of  a  deliberate 
act  of  property  owners  in  cities,  villages,  or  rural  com- 
munities to  secure  overinsurance,  there  is  no  question 
as  to  its  effect  on  the  moral  hazard  and  its  final  effect 
on  the  loss  ratio.  There  results  often  an  inducement 
to  be  careless  in  the  use  of  the  property,  and  in  case 
of  dishonesty  to  produce  by  criminal  carelessness  or 
overt  act  a  loss.  The  resulting  fire  not  only  destroys 
the  property  with  overinsurance  on  it,  but  it  may  also 
spread  to  adjoining  property  and  occasion  losses,  both 
on  insured  and  uninsured  property.  The  Three-fourth 
Value  Clause  thus  makes  it  to  the  interest  of  the  insured 
to  care  for  his  property.  It  has  a  significance  not 
only  for  all  insured  property  owners,  but  also  for  other 
property  owners  and  the  public  at  large.  It  reduces 
the  moral  hazard  among  holders  of  insured  property,  and 
this  contributes  to  producing  a  fair  burden  in  the  charge 
for  each.  It  reduces  the  hazard  for  those  whose  prop- 
erty is  not  insured,  and  it  is  in  harmony  with  good  public 
policy  because  it  is  in  opposition  both  to  criminal  acts 
and  undue  carelessness  in  the  use  of  property. 

The  Three-fourth  Loss  Clause.  —  Another  clause 
which  was  intended  for  the  same  general  purpose  was 
the  Three-fourth  Loss  Clause;  that  is,  the  company 
was  not  liable  for  a  sum  in  excess  of  three  fourths  of  the 
total  loss.  In  this  clause,  loss  and  not  value  of  the 
property  was  the  measure  of  liability,  but  in  either 


LIMITATION  OF  LIABILITY  187 

case  the  effect  was  to  compel  the  owner  to  carry  a  part 
of  his  insurance.  These  clauses  are  not  now  in  general 
use,  due  in  part  to  the  laws  of  some  states  and  in  part 
to  the  coinsurance  clause,  the  relation  of  which  to  these 
clauses  will  be  discussed  later.  This  effort  on  the  part  of 
the  companies  to  limit  their  liability  to  a  certain  propor- 
tion of  the  value  of  the  property  led  to  much  opposition 
on  the  part  of  property  owners  and  in  some  states  to 
the  enactment  of  laws  designed  to  prohibit  their  use. 

Valued-policy  Laws.  —  The  laws  which  were  enacted 
to  prevent  the  preceding  clauses  were  called  Valued- 
policy  Laws.  Wisconsin,  in  1874,  was  the  first  state 
to  pass  such  a  law,  and  later  many  other  states  enacted 
a  similar  law.  These  laws  were  honestly  but  mistakenly 
intended  to  right  an  unquestioned  evil.  The  history 
of  their  enactment  and  operation  aids  in  explaining  in 
part  the  present  difficulty  in  securing  agreements  be- 
tween the  public  and  insurance  officials  in  respect  to 
rates,  taxation,  and  other  regulatory  aspects  of  the 
insurance  business.  The  condition  which  led  to  the 
enactment  of  such  laws  is  well  described  by  A.  Dean 
in  his  "  The  Rationale  of  Fire  Rates  "  as  follows : 

"Thirty  years  ago  farm  property  formed  a  much  larger  propor- 
tion of  our  aggregate  national  wealth  than  it  does  to-day.  At  that 
time  the  tremendous  growth  of  our  manufacturing  and  transpor- 
tation facilities,  and  the  concentration  of  population  in  our  cities, 
was  just  beginning.  The  fire  companies  were  then  deriving  a 
steady  revenue  from  the  insurance  of  farm  property,  which  as  a 
class  was  considered  doubly  desirable,  because  it  had  been  steadily 
profitable,  and  because  it  was  free  from  the  dangers  of  sweeping 
conflagrations  which  in  every  city  jeopardized  the  entire  assets  of 
a  company. 


i88  PRINCIPLES  OF  INSURANCE 

"Every  company  wrote  farm  business  freely  through  its  local 
agents,  under  the  same  liberal  conditions  as  other  classes  of  prop- 
erty. The  volume  of  farm  business  and  its  exceptional  desirability 
led  some  managerial  genius  to  conceive  the  idea  that  he  could 
largely  increase  the  premiums  of  his  company  from  this  source  by 
sending  out  traveling  solicitors  through  the  country  districts,  after 
the  manner  of  the  lightning-rod,  chain-pump,  and  patent-churn 
people. 

"As  these  solicitors  were  selected  for  their  glibness  and  push 
rather  than  for  their  character  or  knowledge  of  the  business,  and 
as  neither  their  judgment  nor  honesty  could  be  trusted,  the  plan 
was  adopted  of  taking  payment  in  notes  instead  of  cash.  An 
elaborate  application  containing  a  cut-throat  warranty  was  pre- 
pared, under  which  the  assured  surrendered  every  equitable  right 
and  became  responsible  for  any  over-valuation  of  his  property; 
and  to  make  assurance  doubly  sure  every  policy  contained  a 
printed  stipulation  that  the  company  should  be  liable  for  only  three 
fourths  of  any  loss  that  might  occur.  This  plan  relieved  the  com- 
pany of  any  necessity  for  the  services  of  local  agents,  selected  for 
their  honesty  and  skill.  There  was  no  cash  to  handle ;  no  danger 
of  defalcations  and  (with  a  policy  condition  which  compelled  the 
assured  to  carry  one  fourth  of  the  insurance  for  which  he  had 
paid)  no  danger  from  overinsurance.  Under  this  jug-handle  ar- 
rangement it  became  possible  to  sell  fire  indemnity,  like  tinware, 
by  peddling. 

"The  farmer  is  generally  ready  to  purchase  anything  he  can 
pay  for  with  a  note,  and  as  '  a  business  getter '  the  plan  was  a  suc- 
cess. In  a  few  years  the  agricultural  regions  swarmed  with  travel- 
ing solicitors  ready  to  sell  a  farmer  a  patent  churn,  windmill, 
stump  puller,  or  fire  policy  with  the  same  glib  disregard  of  truth. 
These  tramp  solicitors  were,  as  a  rule,  ignorant,  unscrupulous 
adventurers.  They  were  paid  by  a  percentage  of  the  premiums, 
and  it  was,  of  course,  to  their  interest  to  make  as  large  a  sale  of 
indemnity  to  every  buyer  as  possible,  regardless  of  his  actual  needs. 
The  companies  themselves  could  afford  to  be  indifferent  to  the 
amount  of  insurance  a  man  procured,  as  misrepresentations  in 


LIMITATION  OF  LIABILITY  189 

application  could  be  used  to  deny  liability,  and  in  any  event,  the 
assured  could  not  collect  more  than  three  fourths  of  his  actual  loss. 
In  time,  the  adjustment  of  losses  revealed  the  full  iniquity  of  this 
plan,  and  in  every  farming  community  fire  insurance  came  to  be 
regarded  as  a  swindle.  Of  the  hundreds  of  fire  institutions  then 
doing  business,  not  over  four  or  five  at  most  were  implicated. 
Nineteen  companies  out  of  twenty  vainly  protested  at  the  bucca- 
neering methods  of  these  so-called  farm  companies,  believing  they 
would  bring  the  entire  business  into  reproach  and  subject  it  to 
inimical  legislation.  These  apprehensions  were  well  founded. 
The  industry  of  fire  insurance  became  non  grata  in  every  state 
where  the  farmers  had  the  controlling  voice  in  legislation,  and  the 
entire  insurance  community  has  been  made  to  suffer  ever  since  for 
the  sins  of  a  few  unprincipled  adventurers. 

"The  American  farmer  to-day  is  the  hereditary  foeman  of  fire 
insurance;  he  makes  no  distinction  between  companies  on  ac- 
count of  character,  record,  or  methods;  the  few  companies 
whose  solicitors  he  learned  to  distrust  in  the  palmy  days  of  farm 
insurance  are  typical  of  the  whole  body  of  fire  underwriters.  In  his 
ignorance  of  facts,  the  readiest  remedy  that  occurred  to  the  agri- 
culturist was  to  wipe  out  the  whole  iniquity  with  a  sweeping  law 
which  required  that  the  amount  of  insurance  should  be  taken  as 
the  real  value  and  measure  of  loss,  regardless  of  policy  conditions 
or  actual  loss." 

This  situation  was  a  product  of  competition  full  and 
free  in  the  fire  insurance  business  and  is  but  one  illus- 
tration of  the  many  evils  which  such  a  system  has 
brought  in  its  application  to  the  insurance  business 
with  respect  to  ratemaking.  The  acts  of  some  com- 
panies are  doubtless  responsible  in  large  part  for  the 
public  disfavor,  just  as  the  acts  of  some  railway  officials 
or  big  business  officials  are  responsible  for  the  public 
suspicion  in  respect  to  their  methods.  In  the  opposition 
created  there  has  resulted  loss  for  both  parties.  This 


ioo  PRINCIPLES  OF  INSURANCE 

Valued-policy  Law  where  not  already  adopted  by  some 
states  is  introduced  from  time  to  time  as  a  bill  in  the 
legislature,  although  there  is  a  growing  sentiment 
against  the  principles  of  the  law,  and  a  limited  number 
of  states  have  repealed  such  laws.  It  is  not  easy  for 
the  citizen  not  informed  in  insurance  to  understand 
why  the  law  is  opposed  to  the  fundamental  theory  of 
fire  insurance.  But  this  is  true  primarily  because  it 
nullifies  indemnity  as  a  principle  in  fire  insurance. 

Assigned  Bases  for  Valued-policy  Laws.  —  The  defense 
of  this  law  in  the  state  legislature  and  among  property 
owners  usually  is,  that  it  is  the  business  of  the  fire  in- 
surance companies  and  its  agents  to  satisfy  themselves 
as  to  the  amount  of  insurance  which  they  wish  to  grant 
on  a  property.  This  could  not  be  done  in  actual  prac- 
tice without  very  greatly  increasing  the  present  large 
expenses  of  the  business,  and  this  added  expense  would 
necessarily  have  to  be  borne  by  the  property  owners. 
Even  granting  that  the  most  complete  provision  should 
be  made  for  inspecting  all  property  to  be  insured,  there 
would  need  to  be  frequent  reinspections  during  the 
continuance  of  the  policy.  The  value  of  property  is 
continually  changing,  due  to  changes  in  business  condi- 
tion, the  growth  of  cities  and  communities,  to  natural 
depreciation,  and  other  causes.  But  the  most  detailed 
system  of  inspection  must  rely  upon  the  property  owner 
for  some  kinds  of  information.  He  is  in  a  position  to 
supply  all  the  information  in  the  case  of  some  kinds  of 
risks,  and  this  without  any  cost  to  himself.  If  the 
insurer  is  considered  the  buyer  of  the  risk,  the  prin- 
ciple of  caveat  emptor  has  no  place  in  the  transaction. 


LIMITATION  OF  LIABILITY  191 

The  insured  by  the  act  of  sale  is  doing  a  deed  the  conse- 
quences of  which  are  not  limited  to  himself.  To  the 
extent  that  he  aids  in  determining  a  fair  fire  rate  for 
his  insurance  and  cooperates  in  securing  only  indemnity, 
to  this  extent  he  is  doing  a  service  to  all  other  owners 
of  insured  property.  That  the  insurance  company 
often  resists  the  payment  of  claims  is  no  justification 
for  such  a  law.  To  the  extent  that  this  is  true,  whether 
fairly  or  unfairly  done,  there  are  remedies  in  the  courts. 
Judges  and  juries  cannot  be  said,  on  the  basis  of  past 
records,  to  favor  the  companies  at  the  expense  of  the 
insured.  The  legislatures  and  the  state  officials  are  also 
empowered  to  supervise  the  business  and  to  protect 
the  insured.  The  recommendations  of  a  committee 
appointed  by  the  legislature  of  North  Carolina  to  in- 
vestigate the  fire  insurance  business  may  be  quoted 
as  expressing  the  more  intelligent  opinion  and  tendency 
in  respect  to  Valued-policy  legislation.  The  committee 
did  not  recommend  the  enactment  of  such  a  law  because : 
(a)  it  changes  the  nature  of  the  contract  as  one  of  in- 
demnity to  an  absolute  promise  to  pay  the  amount 
fixed  in  the  contract,  (b)  As  by  the  statistics  ninety 
per  cent  of  the  losses  are  partial  and  only  ten  per  cent  are 
total,  the  contract  would  remain,  as  now,  practically 
one  of  indemnity,  (c)  The  tendency  would  be  to  in- 
crease the  number  of  total  losses  and  increase  the  fire 
waste,  (d}  It  increases  the  total  cost  of  insurance  con- 
trary to  the  general  desire  to  reduce  this  cost. 

The  Average  Clause  is  sometimes  considered,  espe- 
cially in  this  country,  as  synonymous  with  coinsurance, 
and  sometimes  to  refer  to  that  clause  in  the  policy 


i92  PRINCIPLES  OF  INSURANCE 

which  provides  what  part  of  the  total  sum  insured  shall 
be  applied  to  specified  parts  of  the  property  both  in 
respect  to  the  units  of  the  property  and  their  location. 
In  this  sense  it  is  purely  a  clause,  defining  the  distribu- 
tion of  the  liability  and  not  limiting  it.  This  last  use 
is  the  more  correct  one. 

The  Coinsurance  Clause.  —  The  Coinsurance  Clause 
has  caused  as  much  discussion  and  legislation  as  the 
Valued-policy  Clauses.  Just  as  the  purpose  of  the 
latter  was  to  prevent  overinsurance,  so  the  former  — 
coinsurance  —  is  intended  to  prevent  underinsurance. 
The  clause  takes  the  form  of  a  statement  which  provides 
"  in  consideration  of  the  reduced  rate  at  which  this 
policy  is  written,  it  is  expressively  stipulated  and  made 
a  condition  of  the  contract  that  in  the  event  of  loss 
this  Company  shall  be  liable  for  no  greater  proportion 
thereof  than  the  amount  hereby  insured  bears  to  x 
per  cent  of  the  actual  value  of  the  property  described 
herein  at  the  time  when  such  loss  shall  happen  nor  for 
more  than  the  proportion  which  this  policy  bears  to  the 
total  insurance  thereon." 

The  Fire  Insurance  Rate  and  a  Tax  Compared.  — 
That  is,  under  the  coinsurance  agreement  the  insured  is 
made  insurer  with  the  company  for  that  amount  of  in- 
surance which  is  below  an  agreed-upon  percentage  of  the 
value  of  the  property.  If  the  cost  of  the  loss  of  property 
by  fire  is  to  be  equitably  assessed,  it  is  just  as  important 
that  property  be  insured  to  an  agreed-upon  value  or 
the  rate  adjusted  for  the  deficiency  as  it  is  that  it  be 
not  overinsured.  The  rate  in  fire  insurance  depends 
not  only  upon  the  amount  of  the  fire  loss,  but  also  for 


LIMITATION  OF  LIABILITY  193 

individuals  upon  the  percentage  of  value  that  is  insured. 
Suppose  a  city  had  decided  that  it  must  raise  $1,000,000 
for  public  expenditures  and  that  the  property  value 
to  be  levied  upon  was  $100,000,000.  This  would  neces- 
sitate a  tax  rate  of  one  per  cent.  Now  if  this  tax  is  to 
be  levied  as  a  proportional  one,  that  is,  each  citizen  is 
to  pay  in  proportion  to  his  property,  it  is  necessary  if 
equity  is  to  be  secured  that  the  property  of  each  be 
returned  for  taxation  at  its  true  and  full  value  or  at 
some  uniform  value.  If  one  half  the  property  owners 
return  their  property  at  one  half  its  value,  they  will 
pay  into  the  treasury  only  $250,000,  while  the  other  half 
of  the  citizens  will  pay  $500,000.  If  the  first  group 
are  permitted  to  reduce  their  valuation  for  tax  purpose, 
then  the  rate  must  be  increased  in  order  to  raise  the 
$1,000,000  for  the  public  needs.  If  likewise  a  definite 
sum  must  be  raised  to  pay  the  fire  losses,  this  sum  should 
be  assessed  upon  property  owners  alike,  that  is,  upon 
some  definite  valuation.  It  makes  no  particular  dif- 
ference whether  it  is  a  100  per  cent  or  an  80  per  cent  valua- 
tion, so  long  as  each  return  his  property  on  the  same 
basis  and  has  applied  to  each  the  same  rate. 

The  present  method  of  schedule-rating  risks  is  one 
under  which  the  hazards  incident  to  each  risk  are  ana- 
lyzed with  the  purpose  of  securing  from  each  his  equi- 
table contribution  to  the  fire  loss  fund.  Each  owner  of 
property  under  this  system,  when  it  is  properly  applied, 
is  induced  to  improve  his  risk  and  thus  reduce  the  fire 
loss.  The  rate  must  be  derived  from  some  assumed 
and  definite  value  of  the  property,  just  as  the  tax  rate 
cannot  be  determined  without  knowing  the  value  of 
o 


I94  PRINCIPLES   OF  INSURANCE 

the  property  from  which  the  revenue  is  to  be  derived. 
The  following  illustration  adapted  from  a  report  of  the 
fire  insurance  investigating  committee  of  New  York 
shows  why  this  coinsurance  clause  is  necessary  and 
how  it  works  in  actual  practice.  "  There  are  statistics 
that  show  that  on  a  certain  class  of  buildings  there  are 
approximately  the  following  losses  for  every  $100  worth 
of  property  value : 

On  the  average,  out  of  every  100  fires : 

82  do  a  damage  of  less  than  $10  and  on  the  average  $2,  making 

all  together  a  loss  of $164.00 

6  do  a  damage  of  less  than  $20  and  more  than  $10  and  on  the 

average  $14,  making  all  together  a  loss  of 84.00 

3  do  a  damage  of  less  than  $30  and  more  than  $20  and  on  the 

average  $25,  making  all  together  a  loss  of 7S-oo 

2  do  a  damage  of  less  than  $40  and  more  than  $30  and  on  the 

average  $35,  making  all  together  a  loss  of 70.00 

i  does  a  damage  of  less  than  $60  and  more  than  $50  and  on 

the  average  $55,  making  all  together  a  loss  of •     55.00 

i  does  a  damage  of  less  than  $70  and  more  than  $60  and  on  the 

average  $65,  making  all  together  a  loss  of 65.00 

i  does  a  damage  of  less  than  $80  and  more  than  $70  and  on  the 

average  $75,  making  all  together  a  loss  of 75-oo 

1  does  a  damage  of  less  than  $90  and  more  than  $80  and  on  the 
average  $85,  making  all  together  a  loss  of 85.00 

2  do  a  damage  of  less  than  $100  and  more  than  $90  and  on  the 
average  $99,  making  all  together  a  loss  of 198.00 

100 Total $916.00 


"  That  is,  every  100  fires  burn  all  together  $916  worth  of 
property,  supposing  the  property  in  each  case  to  have  had 
a  value  of  $100.  Now  if  on  each  of  these  houses  just 
$10  of  insurance  had  been  carried  for  every  $100  of  value, 
the  losses  to  the  companies  would  have  been  as  follows : 

82  losses  of  $2  each,  making  all  together $164.00 

1 8  losses  of  $10  each,  making  all  together 180.00 

loo Total $344.00 


LIMITATION  OF  LIABILITY  195 

"It  is  obvious  that  on  the  eighteen  losses  in  which 
the  damage  was  more  than  $10  only  the  face  of  the  policy 
would  be  payable.  If  we  assume  that  there  is  one  fire 
out  of  every  100  houses  at  risk,  100  fires  will  represent 
10,000  risks,  and  the  premium  that  must  be  collected 
from  each  of  these  10,000  risks  to  pay  this  loss  of  $344 
will  be  $344/10,000  or  3.44  cents.  This,  it  is  understood, 
is  the  net  premium  without  any  loading  for  expense. 
Three  and  forty-four  one  hundredths  cents  is  the  actual 
premium,  but  the  rate  based  on  $100  is  ten  times  this, 
or  34.4  cents;  that  is,  $10  of  insurance  at  the  rate  of 
34.4  cents  per  $100  amounts  to  a  premium  of  3.44 
cents. 

Now  in  an  exactly  similar  way  the  cost  to  the  com- 
pany of  carrying  $20  of  insurance  can  be  computed; 
there  will  be : 

82  losses  of  $2,  making  all  together $164.00 

6  losses  of  $14,  making  all  together 84.00 

1 2  losses  of  $20,  making  all  together 240.00 

loo Total $488.00 


"To  pay  this  loss  each  of  the  10,000  risks  must  be  as- 
sessed $1488/10,000  or  4.88  cents.  This  is  the  premium 
for  $20  of  insurance,  but  the  rate,  on  the  basis  of  $100, 
is  five  times  this  or  24.4  cents ;  that  is,  $20  of  insurance 
at  a  rate  of  24.4  cents  per  $100  will  amount  to  a  premium 
of  4.88  cents. 

"This  same  principle  can  be  carried  out  for  any  given 
amount  of  insurance.  Take  just  one  more  case:  sup- 
pose the  insurance  to  be  $80.  There  will  then  be  pay- 
able by  the  company : 


196  PRINCIPLES  OF  INSURANCE 

82  losses  of  $2,  making  all  together $164.00 

6  losses  of  $14,  making  all  together 84.00 

3  losses  of  $25,  making  all  together 7S-oo 

2  lossesfof  $35,  making  all  together 70.00 

i  loss  of  $45,  making  all  together 45.00 

i  loss  of  $65,  making  all  together 65.00 

i  loss  of  $75,  making  all  together 75-oo 

3  losses  of  $80,  making  all  together 240.00 

100 Total $873.00 

"  The  sum  that  must  be  collected  from  each  of  the 
10,000  risks  will  be  $873/10,000  or  8.73  cents.  This  is  the 
premium  for  $80  of  insurance,  but  the  rate  on  the  basis 
of  $100  will  be  f  of  this  or  10.91  cents;  that  is,  $80 
of  insurance  at  a  rate  of  10.91  cents  per  $100  gives  a 
premium  of  8.73  cents. 

"  In  the  table  below  are  presented  the  rates  that  will 
correspond  to  various  percentages  of  insurance  to  value : 

If  the  insurance  is  10%  of  the  value,  the  rate  should  be  ...  $0.34 

If  the  insurance  is  20%  of  the  value,  the  rate  should  be  ...  .24 

If  the  insurance  is  30%  of  the  value,  the  rate  should  be  ...  .20 

If  the  insurance  is  40%  of  the  value,  the  rate  should  be  ...  .17 

If  the  insurance  is  50%  of  the  value,  the  rate  should  be  ...  .15 

If  the  insurance  is  60%  of  the  value,  the  rate  should  be  ...  .13 

If  the  insurance  is  70%  of  the  value,  the  rate  should  be  ...  .12 

If  the  insurance  is  80%  of  the  value,  the  rate  should  be  ...  .11 

If  the  insurance  is  90%  of  the  value,  the  rate  should  be  ...  .10 

If  the  insurance  is  100%  of  the  value,  the  rate  should  be  ...  .09 

"  This  is  not  only  a  practical  demonstration  of  the  fact 
that  the  rate  in  fire  insurance  must  depend  upon  the 
percentage  of  insurance  carried,  but  if  the  figures  upon 
which  it  is  based  were  correct,  it  would  be  a  determina- 
tion of  what  the  net  rate  should  be.  It  is  understood, 
however,  that  the  particular  figures  here  given  are  only 
in  way  of  illustration ;  the  principle  that  the  rate  falls 
as  the  ratio  of  insurance  carried  increases  holds  whatever 


LIMITATION  OF  LIABILITY  197 

the  figures  that  are  used,  even  though  large  losses  were 
relatively  more  frequent  than  small  ones." 

The  principle  that  is  here  established  is  that  the  rate 
in  fire  insurance  must  equitably  depend  upon  the  per- 
centage of  insurance  carried,  and  that,  for  example,  a  rate 
of  ninety-three  cents,  which  might  be  right  if  80  per  cent 
of  insurance  were  carried,  would  be  much  too  low  if 
only  30  per  cent  were  carried. 

The  Fire  Rate  and  Life  Rate  Compared.  —  The  situa- 
tion is  exactly  the  same  as  in  life  insurance,  where  the 
rate  must  equitably  depend  upon  the  age.  A  premium 
of  $23  for  a  man  25  years  old  would  be  far  too  low  for  a 
man  65  years  old.  If  insurance  were  sold  to  these  two 
men  at  the  same  price,  the  effect  would  be  that  the  young 
man  would  be  helping  to  pay  for  the  hazard  of  the  older 
man  and,  still  more  to  the  point,  that  eventually  young 
men  would  refuse  to  enter  into  such  an  unfair  bargain 
and  the  company  would  be  doing  a  business  only  with 
old  men  for  whom  confessedly  the  rate  would  be  too  low. 

The  principle  is  exactly  the  same  in  fire  insurance. 
If  a  man  who  carries  80  per  cent  of  insurance  is  charged 
the  same  rate  as  a  man  who  carries  only  30  per  cent,  the 
effect  is  that  the  man  who  carries  80  per  cent  will  be 
helping  to  pay  for  the  hazard  of  him  who  carries  only 
30  per  cent,  and  still  more  to  the  point  that  the  tendency 
would  be,  under  this  unfair  arrangement,  for  men  to 
refuse  to  insure  for  the  larger  amount.  But  that  this 
"  adverse  selection  "  does  not  operate  so  strongly  as 
in  life  insurance  is  due  to  two  causes ;  first,  that  the 
principle  is  not  so  clearly  seen  as  in  life  insurance,  and, 
second,  that  full  or  nearly  full  insurance  is  in  most 


198  PRINCIPLES  OF  INSURANCE 

cases  needed  at  any  price ;  this  is  particularly  so  where 
the  property  is  mortgaged,  the  condition  of  the  mort- 
gage requiring  that  the  property  be  well  covered  by 
insurance.  The  situation  then  is  this:  equity  to  the 
policyholder  demands  that  the  rate  should  be  adjusted 
to  the  percentage  of  insurance  carried,  and  to  a  certain 
extent  the  result  is,  if  this  is  not  done,  that  insurers  will 
carry  less  insurance  than  conditions  demand. 

Now  it  is  impossible  to  base  a  rate  upon  the  percentage 
of  insurance  to  value,  unless  this  percentage  is  known. 
But  to  know  it,  means  to  know  the  value  of  the  property, 
and  here  we  are  brought  up  against  the  same  difficulty 
that  arises  in  the  case  of  the  valued  policy,  namely, 
that  as  a  practiced  matter,  it  is  impossible  for  the  com- 
pany to  ascertain  values.  In  the  consideration  of  the 
valued  policy  law  we  have  already  reached  the  conclusion 
that  this  work  must  devolve  upon  the  insured  for  the 
reason  that  he,  if  anybody,  is  the  one  who  knows  the 
values ;  at  any  rate  he  ought  to  know. 

That  the  responsibility  belongs  to  the  insured  is 
recognized  in  an  agreement  known  as  the  coinsurance 
clause,  in  which  the  insured  warrants  that  he  will  main- 
tain at  least  a  certain  specified  ratio  of  insurance  to 
value  and,  failing  so  to  do,  he  shall  be  considered  to  be 
himself  an  insurer  for  the  deficit. 

That  is,  a  failure  to  maintain  the  provisions  of  this 
warranty,  instead  of  tending  to  invalidate  the  insurance, 
simply  brings  in  the  insured  in  a  new  role,  namely,  as 
insurer  for  the  balance  by  which  the  actual  insurance 
that  he  carries  falls  short  of  what  he  warranted  to  carry. 

Or  to  state  it  differently,  by  the  agreement  the  war- 


LIMITATION  OF  LIABILITY  199 

ranty  is  automatically  observed  because  at  the  instant 
that  the  insurance  in  companies  falls  short  of  the  re- 
quired amount  the  insured  himself  enters  as  a  "  co- 
insurer." 

This,  when  understood,  is  reasonable,  but  its  conse- 
quences are  not  easily  seen.  To  understand  its  workings 
completely  it  is  necessary  to  take  some  concrete  cases. 

Effects  of  the  Coinsurance  Clause.  —  In  the  following 
examples  an  80  per  cent  coinsurance  clause  will  be 
understood,  that  is,  one  in  which  the  insured  warrants 
that  he  will  keep  his  property  insured  for  at  least  80 
per  cent  of  its  value.  Only  cases  will  be  considered  in 
which  the  insured  fails  to  live  up  to  his  agreement,  as, 
of  course,  otherwise  the  settlements  will  be  the  same  as 
though  there  were  no  such  clause. 

CASE  I 

Value $100,000 

Insurance 50,000 

Loss 20,000 

Here  the  agreement  called  for  $80,000  of  insurance; 
the  policyholder  is,  therefore,  a  coinsurer  for  $30,000. 
The  insurance  therefore  stands : 

Companies $50,000 

Himself 30,000 

Total $80,000 

On  any  loss  therefore  the  companies  contribute  f 
and  he  himself  contributes  f ;  on  the  loss  of  $20,000 
therefore  the  contributions  are : 

Companies $12,500 

Himself ,         7,5°o 


200  PRINCIPLES  OF  INSURANCE 

That  is,  in  spite  of  the  fact  that  he  carries  insurance 
of  $50,000  he  is  able  to  collect  only  $12,500 ;  the  balance 
of  the  loss  he  is  compelled  to  stand  himself.  This  is 
true  because  his  rate  was  based  on  the  assumption  that 
he  would  carry  80  per  cent  of  insurance ;  in  reality  he 
carried  only  50  per  cent  of  insurance  and  so  doing  he 
should  have  paid  a  higher  rate.  The  rate  that  he  paid 
was  not  sufficient  under  these  circumstances  to  buy 
complete  indemnity,  and  the  deficiency  was  measured 
by  his  own  forced  contribution  of  $7500. 

CASE  n 

Value $100,000 

Insurance 50,000 

Loss 80,000 

Here  the  value  and  insurance  are  the  same  as  in  the 
previous  case,  the  only  difference  being  that  the  loss 
is  larger,  namely,  as  it  happens,  equal  to  the  amount  of 
insurance  that  he  had  agreed  to  carry. 

Here,  as  before,  as  he  is  a  coinsurer  for  $30,000, 
the  company's  contribution  will  be  f  and  his  f .  But 
f  of  $80,000  is  $50,000,  the  full  face  value  of  his  policy; 
he  therefore  obtains  from  the  company  the  full  amount 
of  his  insurance,  the  $30,000  that  he  must  himself  con- 
tribute being  only  the  amount  by  which  his  insurance 
falls  short  of  the  loss. 

CASE  III 

Value   .     .    .    x $100,000 

Insurance 50,000 

Loss 90,000 


LIMITATION  OF  LIABILITY  201 

Here,  as  in  the  two  previous  cases,  the  contribution 
of  the  company  will  be  f  and  his  own  contribution  f . 
But  f  of  $90,000  is  $56,250.  This  is  more  than  the 
face  of  the  policy,  and  as  the  liability  of  the  company 
ceases  at  $50,000  the  policyholder  must  stand  this 
loss  of  $6250  in  addition  to  his  own  contribution  as  a 
coinsurer  of  $33,750;  that  is,  all  together,  the  $40,000 
by  which  his  loss  exceeds  his  insurance. 

The  conclusions  are  these :  the  coinsurance  clause 
is  operative,  in  effect,  only  when  the  loss  is  less  than 
that  percentage  of  the  value  that  is  named  in  the  agree- 
ment; on  losses  above  this,  for  instance,  total  losses, 
the  company  is  liable  for  the  entire  amount  of  the 
insurance.  An  interesting  consequence  of  this  may  be 
mentioned.  If  the  coinsurance  clause  had  been  in 
use  to  any  large  extent  in  San  Francisco,  the  rates  would 
have  been  correspondingly  lower  and  the  amount  of 
insurance  carried  would  have  been  higher,  and  yet  the 
insured  would  have  received  the  full  amount  of  their 
insurance  because  the  losses  were  all  practically  total. 

The  lowering  of  the  rate  has  been  referred  to;  the 
effect  of  the  introduction  of  the  coinsurance  clause  is, 
of  course,  so  far  as  the  liability  of  the  company  is  con- 
cerned, to  fix  the  ratio  of  insurance  to  value,  so  that  it  is 
possible  and  customary,  upon  this  basis,  to  make  the 
rate  depend  upon  the  percentage,  as  we  have  seen  that 
in  equity  is  due. 

Usually  80  per  cent  is  taken  as  the  standard,  the  rate 
for  90  per  cent  and  100  per  cent  coinsurance  being  pro- 
portionately lower  and  the  rate  for  percentages  less 
than  80  being  proportionately  higher.  In  some  places, 


202  PRINCIPLES  OF  INSURANCE 

as  in  New  York  City,  the  insured  is  not  free  to  choose 
what  percentage  of  insurance  he  will  carry ;  in  that  case, 
usually,  as  in  New  York  City,  80  per  cent  or  over  is 
prescribed.  In  practice  this  is  not  so  arbitrary  and 
harsh  as  might  seem  to  be  the  case ;  first,  because  most 
of  the  insured  desire  to  carry  at  least  80  per  cent  of  in- 
surance, and  second,  because  where,  as  in  fireproof 
office  buildings,  the  insured  might  very  naturally  de- 
sire to  carry  only  partial  insurance,  as  a  matter  of 
fact  full  insurance  can  be  given  at  scarcely  any  ad- 
ditional cost. 

Justification  of  Coinsurance.  —  The  general  conclu- 
sions we  reach  with  regard  to  the  coinsurance  clause 
are  these :  that  the  principle  upon  which  it  is  founded, 
namely,  that  rates  should  be  based  upon  the  percentage 
of  the  insurance  carried,  is  not  only  sound,  but  is  abso- 
lutely requisite  if  the  equities  of  the  insured  are  to  be 
preserved ;  second,  that  the  coinsurance  clause  rightly 
recognizes  that  as  a  practical  matter  the  responsibility 
for  maintaining  a  given  percentage  of  insurance  must 
rest  with  the  insured ;  third,  that  the  operation  of  the 
agreement  is  automatic  and  fair. 

In  addition  to  the  theoretical  justification  of  such 
a  clause  there  are  also  large  practical  considerations 
which  justify  its  use.  Its  absence  is  probably  responsible 
for  the  existence  of  the  most  objectionable  forms  of 
discrimination.  We  have  seen  that  in  non-protected 
areas  there  is  a  tendency  to  purchase  full  and  in  some 
cases  overinsurance. 

In  protected  districts  there  is  a  tendency  to  under- 
insurance, since  most  of  the  losses  are  partial  and  the 


LIMITATION  OF  LIABILITY  203 

"  spread  "  of  the  insurance  is  very  great ;  that  is,  a 
small  amount  of  insurance  gives  a  large  amount  of  pro- 
tection. This  is  especially  important  in  the  case  of 
large  property  values.  The  property  is  often  composed 
of  different  units,  each  with  good  construction  and 
protection.  The  owners  of  these  large  properties  are 
able  to  secure  the  blanket  policy,  the  face  amount  of 
which  is  but  a  small  percentage  of  the  total  value  of 
the  property  insured.  Where  the  coinsurance  clause  is 
prohibited  by  law,  such  owner  often  secured  adequate 
protection  on  his  diverse  property  by  a  small  amount 
of  insurance.  The  small  property  owner  was  not  only 
at  a  disadvantage  in  bargaining,  but  was  compelled  by 
the  very  character  of  his  property  to  purchase  a  large 
amount  of  insurance. 

Paradoxical  as  it  appears,  much  of  the  opposition 
to  the  principle  of  coinsurance  has  come  from  small 
property  holders,  and  by  this  opposition  they  have  fur- 
thered the  interests  of  the  large  property  owner.  The 
property  of  the  small  owner  is  all  subjected  to  a  fire, 
while  that  of  a  large  owner  is  not.  This  coinsurance 
clause  was  not  applied  to  many  classes  of  risks  such  as 
dwellings  and  public  property.  Its  chief  application 
was  to  mercantile  and  manufacturing  risks.  This 
clause  has  long  been  in  use  hi  marine  insurance  although 
the  arguments  for  its  application  in  this  kind  of  insur- 
ance are  not  as  strong  as  in  the  case  of  fire  insurance. 
It  is  also  generally  used  in  the  European  countries,  and 
in  many  of  them  it  is  required  by  law.  Any  system  of 
state  fire  insurance  would  need  to  apply  it  for  the  same 
reasons  that  in  levying  proportional  taxes  an  effort 


204  PRINCIPLES  OF  INSURANCE 

is  made  to  secure  equity  by  taxing  the  property  of  each 
at  some  uniform  valuation. 

Insurable  Interest.  —  The  subject  of  Insurable  Inter- 
est is  indirectly  related  to  liability  in  that  the  establish- 
ment of  this  relationship  to  the  insured  by  a  third  party 
affects  the  liability  of  the  company  to  pay  sums  to 
persons  other  than  the  insured.  Clause  (/)  recognizes 
this  situation  when  it  provides  for  the  recognition  of  the 
interests  of  a  mortgagee  or  other  creditor  of  the  insured. 
The  condition  of  insurable  interests  may  arise  in  any 
one  of  various  ways.  Whenever  any  one  has  an  interest 
of  a  monetary  value  in  the  insured  property,  secured 
by  a  mortgage  or  established  otherwise,  which  creates 
a  creditor  relationship,  he  has  the  right  to  insure  the 
property  to  the  extent  of  this  value.  The  courts  have 
been  disposed  to  apply  the  principle  of  insurable  interest 
very  widely.  Consignors  of  goods  in  the  goods  shipped, 
contractors  in  building  under  construction,  carriers 
in  goods  transported,  commission  merchants  in  goods 
held  for  sale,  lessee  in  property  leased,  partner  in  the 
property  of  the  partnership  are  but  a  few  illustrations 
of  the  many  circumstances  which  create  an  insurable 
interest. 

The  Mortgage  and  Insurable  Interest.  —  One  of  the 
most  common  cases  in  which  an  insurable  interest  arises 
is  in  connection  with  a  mortgage.  The  policy  contains 
clauses  which  attempt  to  determine  the  relationship 
among  the  mortgagor,  the  mortgagee,  and  the  insurer. 
The  courts  in  general  have  been  inclined  to  interpret 
and  apply  the  policy  and  these  clauses  in  a  manner 
to  protect  and  serve  the  interests  of  the  holder  of 


LIMITATION  OF  LIABILITY  205 

the  mortgage.  Clause  (/)  of  the  standard  policy  recites 
that  "  If  an  interest  under  the  policy  exists  in  favor  of 
a  mortgagee,  the  conditions  hereinbefore  contained 
shall  apply  in  the  manner  expressed  in  such  provisions, 
and  conditions  of  insurance  relating  to  such  interests  as 
shall  be  written  upon,  attached  or  appended  thereto." 
In  the  decisions  of  the  courts,  it  was  early  established 
that  both  the  mortgagor  and  mortgagee  might  insure 
their  interests  in  the  property.  But  the  situation  might 
arise  where  the  mortgagee  might  secure  from  the  insurer 
the  value  of  his  mortgage  interests  in  the  property  and 
also  collect  the  debt  secured  by  the  mortgage  from  the 
owner  of  the  property.  This  would  make  it  possible 
for  him  to  secure  a  profit  from  the  existence  of  insur- 
ance, and  the  policy  contract  should  be  one  of  indemnity. 
Provision  had  to  be  made  in  the  mortgage  clause  to 
prevent  this  result.  This  was  done  by  providing  that 
the  insurer  upon  paying  to  the  mortgagee  the  loss  which 
represented  his  interest  in  the  property  then  becomes 
subrogated  to  the  mortgage.  That  is,  the  insurance 
company  became  in  effect  possessed  of  the  mortgage 
and  was  entitled  to  recover  from  the  mortgagor.  If, 
however,  the  sum  paid  by  the  insurer  to  the  mortgagee 
was  less  than  the  face  of  the  mortgage,  the  holder  of  the 
mortgage  could  collect  the  remainder  of  his  debt.  Per- 
mitting both  the  mortgagor  and  mortgagee  to  insure 
the  same  property  led  to  confusion,  and  efforts  were 
made  to  devise  a  mortgage  clause  in  which  the  interests 
of  both  were  joined.  The  following  clause  is  a  common 
one  used  as  the  Standard  Mortgage  Clause,  but  without 
the  contribution  feature. 


2o6  PRINCIPLES  OF  INSURANCE 

The  Mortgage  Clause.  —  "  The  interest  of  the  mort- 
gagee shall  not  be  invalidated  by  any  act  or  neglect  of 
the  mortgagor  or  owner  nor  by  foreclosure  or  other 
proceedings  nor  by  change  in  the  title  or  ownership  nor 
by  occupation  of  the  premises  for  purposes  more  hazard- 
ous than  are  permitted  by  the  policy,  and  provided 
that  in  case  the  mortgagor  or  owner  shall  neglect  to 
pay  the  premium  the  mortgagee  on  demand  shall  pay 
the  same ;  provided,  also,  that  any  change  of  ownership, 
occupancy,  or  increase  of  hazard  coming  to  the  knowledge 
of  the  mortgagee,  trustee,  etc.,  shall  be  notified  to  the 
company  and  unless  permitted  by  the  policy  it  shall 
be  noted  thereon  and  the  mortgagee  on  demand  shall 
pay  the  premium  for  such  increased  hazard  for  the  term 
of  the  use  thereof." 

The  Contribution  and  Mortgage  Clause.  —  The  Con- 
tribution Clause  with  its  mortgage  rider,  in  respect  to 
which  this  clause  must  be  applied,  is  as  follows  in  the 
Standard  New  York  Policy.  "  This  company  shall  not 
be  liable  under  this  policy  for  greater  proportion  of  any 
loss  on  the  described  property  .  .  .  than  the  amount 
hereby  insured  shall  bear  to  the  whole  insurance,  whether 
valid  or  not,  or  by  solvent  or  insolvent  insurance,  cover- 
ing such  property,  and  the  extent  of  the  application  of 
the  insured  under  this  policy  or  of  the  contribution  to 
be  made  by  this  company  in  case  of  loss,  may  be  pro- 
vided for  by  agreement  or  condition  written  hereon 
or  attached  or  appended  hereto."  The  mortgage  rider 
has  the  following  language :  "In  case  of  any  other 
insurance  upon  the  within-described  property  this  com- 
pany shall  not  be  liable  under  this  policy  for  a  greater 


LIMITATION  OF  LIABILITY  207 

proportion  of  any  loss  or  damage  sustained  than  the 
sum  hereby  insured  bears  to  the  whole  amount  of  insur- 
ance on  said  property,  issued  to  or  held  by  any  party 
or  parties  having  an  insurable  interest  therein  whether 
as  owner,  mortgagee,  or  otherwise." 

As  an  example  of  the  not  infrequent  difference  of  opin- 
ion among  the  different  courts  in  interpreting  the  insur- 
ance contract,  the  application  of  this  Contribution  Clause 
affords  an  excellent  illustration.  In  the  case  of  the 
Hartford  Insurance  Company  v.  Williams  (Fed.  Rep. 
Vol.  63,  No.  925)  the  court  said,  in  an  appeal  from  the 
lower  court,  which  had  held  that  the  Contribution  Clause 
was  not  effective  and  the  Insurance  Company  could 
recover,  "  we  can  conceive  of  no  other  object  that  the 
parties  could  have  had  in  using  the  words  '  issued  to 
or  held  by  any  party  or  parties  having  insurable  interest 
therein  '  unless  it  was  to  avoid  the  very  construction 
of  the  Clause  which  the  Circuit  Court  appears  to  have 
adopted.  As  before  remarked,  the  concluding  words 
of  the  paragraphs  seem  to  have  been  added  out  of 
abundant  caution  that  there  might  be  no  ground  upon 
which  to  insist  that  the  right  to  pro-rate  was  limited 
to  policies  held  by  the  mortgagee  or  for  his  benefit.  .  .  . 
In  construing  a  contract  like  the  one  now  in  hand  it  is 
our  duty  to  look  to  all  the  provisions  of  the  agreement 
and  to  give  effect  to  what  seems  to  have  been  the  obvious 
intent  and  meaning  of  the  parties.  We  would  not  be 
justified  in  ignoring  an  agreement  in  one  part  of  the 
instrument  which  is  as  purely  expressed  as  language 
could  well  express  it  merely  because  it  limits  to  some 
extent  a  scope  of  general  language  employed  in  another 
part  of  the  instrument." 


2o8  PRINCIPLES  OF  INSURANCE 

Effects  of  the  Mortgage  Clause.  —  The  important 
provisions  and  relations  established  by  these  mort- 
gage clauses  are :  first,  the  mortgagor  is  the  one  who 
takes  out  the  policy,  and  when  a  mortgage  on  the  prop- 
erty is  given,  the  insurer  is  notified  and  gives  his  consent. 
Second,  the  insurer  provides  that  the  mortgagee's 
interests  shall  be  protected  in  various  ways ;  as,  for  ex- 
ample, by  freeing  him  from  the  effects  of  acts  of  neglect 
by  the  mortgagor  and  notification  to  the  mortgagee  of 
a  proposed  cancellation.  Third,  the  mortgagee  agrees 
to  pay  premiums  which  the  mortgagor  neglects  or  refuses 
to  pay,  or  to  pay  any  extra  charge  for  an  increase  in  the 
hazard  of  the  risk  and  further  to  inform  the  insurer  of 
any  change  in  hazard  or  interests  in  the  property  of 
which  he  may  have  knowledge.  If,  however,  the  mort- 
gagee has  knowledge  at  the  time  the  insurance  was 
effected  or  at  the  time  the  mortgage  clause  and  rider 
was  attached,  that  acts  or  facts  existed  which  invali- 
dated the  policy,  he  has  no  right  of  recovery  against 
the  company.  The  courts,  however,  are  disposed  to 
protect  the  interests  of  the  mortgagee  in  every  possible 
manner,  since  it  is  the  mortgagor  who  has  both  control 
and  possession  of  the  property  which  is  the  security 
for  the  loan. 

REFERENCES 

Mortgagee  Clause.    Leo  Levy. 

The  Rights  of  Administrators  and  Executors  over  Real  Property 
in  Connection  with  the  Standard  Policy.  F.  O.  Affeld,  Jr. 

Two  addresses  delivered  to  the  Insurance  Society  of  New  York. 

Protection  of  a  Mortgagee's  Interest  in  Real  Property  by  Insur- 
ance. Robert  Riegel.  The  Journal  of  Political  Economy, 
Vol.  XXIII,  No.  10. 


LIMITATION  OF  LIABILITY  209 

Property  Insurance.    Solomon  S.  Huebner,  Chaps.  IV,  XI. 

Lectures  on  Fire  Insurance,  Part  IV. 

Yale  Readings  in  Insurance  (Fire),  Chaps.  X,  XH. 

The  Business  of  Insurance,  Vol.  I,  Chap.  X. 

A  Treatise  on  the  Law  of  Insurance.    George  Richards. 


CHAPTER  X 

FINANCES   OF   FIRE   INSURANCE 

The  Premium.  —  The  premium  is  the  sum  paid  by 
the  insured  to  the  insurer  for  the  indemnity  promised 
by  the  contract  in  the  event  of  a  loss.  It  is  the  chief 
source  of  income  for  the  company.  Interest  is  earned 
on  these  invested  premiums  and  also  on  whatever  capital 
has  been  contributed  by  the  shareholders.  From  these 
payments  and  their  interest  accumulations  fire  losses, 
expenses  of  transacting  the  business,  and  taxes  must 
be  paid.  Whatever  remains  constitutes  an  income  or 
dividend  to  the  shareholders  on  their  investment. 

Premium  in  Fire  and  Life  Insurance.  —  The  premium 
in  fire  insurance  differs  in  several  respects  from  the 
premium  in  life  insurance.  Every  policy  in  life  insur- 
ance matures  in  some  form;  that  is,  the  principal  sum 
named  in  the  policy  must  be  paid  by  the  insurer,  either 
as  a  death  claim  or  a  matured  endowment.  The  only  ap- 
parent exception  is  when  a  term  policy  is  issued  under 
which  a  certain  proportion  of  the  policyholders  secure 
during  the  term  of  years  insurance  protection  without 
the  policy  maturing  by  death.  The  fire  insurance 
policy  resembles  most  closely  this  kind  of  a  life  insur- 
ance policy,  since  of  all  those  who  purchase  policies, 
some  will  be  paid  the  face  of  the  policy  or  such  part  of 

2ig 


FINANCES  OF  FIRE  INSURANCE  211 

it  as  represents  the  loss  suffered,  while  others  will  have 
no  loss  but  will  secure  the  protection  during  the  existence 
of  the  policy.  It  is  the  protection  which  is  of  primary 
significance  in  the  fire  insurance  contract,  because  no 
property  owner  should  purchase  a  policy  because 
he  expects  to  suffer  a  loss.  The  premium  is  paid  to 
secure  this  protection  and  not  with  the  intention  of 
making  a  profit  from  the  happening  of  an  unforeseen 
event. 

Protection  in  fire  insurance  is  to  be  distinguished 
both  from  prevention  and  profit.  The  mere  fact  of 
having  a  fire  insurance  policy  does  not  manifestly  assure 
the  owner  that  his  property  will  not  burn,  nor  on  the 
other  hand  should  the  possession  of  the  policy  secure 
for  him  a  profit  in  the  event  of  a  fire ;  that  is,  a  sum  in 
excess  of  the  value  of  the  property  destroyed.  The 
protection  consists  simply  in  the  fact  that  in  the  event 
of  a  loss  he  will  be  indemnified. 

In  life  insurance  the  premium  is  adjusted  to  the  age 
and  physical  condition  of  the  insured,  but  in  fire  insur- 
ance no  necessary  relation  exists  between  the  amount 
of  the  premium  and  the  age  of  the  building,  for  the  fire 
risk  does  not  increase  directly  with  age.  Death  is  a 
certainty  for  all  members  of  the  insured  group,  and  the 
length  of  life  is,  for  the  group,  predetermined.  But 
destruction  is  not  a  certainty  for  all  the  buildings  nor 
is  there  a  definite  length  of  life  for  them. 

It  is  only  in  a  broad  sense  that  the  "  physical  condi- 
tion of  the  building  "  and  its  surroundings  is  important 
in  determining  the  premium  in  fire  insurance.  Other 
factors  affecting  the  premium,  such  as  the  laws  applying 


212  PRINCIPLES  OF  INSURANCE 

to  insurance,  taxes,  climatic  conditions,  and  moral  haz- 
ards have  been  discussed.  It  is  often  argued  that  in 
fire  insurance  there  is  a  rate  or  premium  for  each  risk, 
while  in  life  insurance  there  is  a  rate  .or  premium  for 
each  class  of  risks,  based  upon  the  age  of  the  group. 
This  is  true  only  as  a  general  statement.  It  has  been 
shown  that  in  the  age  groups  the  premium  is  sometimes 
adjusted  according  to  the  increased  hazard  of  the  insured 
life.  In  fire  insurance,  the  system  of  schedule  rating 
attempts  to  analyze  the  hazard  of  the  risk  and  deter- 
mines thereby  the  premium  which  should  be  charged. 
But  schedule  rating  is  not  applied  to  all  risks.  The 
advocates  of  classification  as  a  basis  for  rate  making 
in  fire  insurance  attempt  to  apply  the  same  principles 
as  are  used  in  life  insurance.  These  alone  cannot  be 
used  to  determine  fair  and  equitable  premiums. 

The  Premium  as  a  Tax.  —  The  premium  in  fire 
insurance  is  often  considered  as  a  tax  on  the  ground 
that  it  is  simply  the  compulsory  payment  which  must 
be  made  by  the  insured  group  to  meet  the  losses  by  fire. 
This  "  tax  "  is  assessed  by  the  companies;  that  is,  the 
insurer  simply  acts  as  a  collecting  and  distributing  agent. 
There  is  much  similarity  between  the  fire  insurance 
premium  and  an  ordinary  tax,  but  the  comparison 
should  not  be  pushed  too  far.  Fire  insurance,  in  so 
far  as  it  is  conducted  by  stock  companies,  is  a  business, 
the  investors  in  which  expect  to  derive  a  profit  or  a 
return  from  their  invested  capital  through  the  collection 
of  the  premiums.  The  government  collects  a  tax 
with  the  expectation  of  returning  all  of  it  to  the  public 
indiscriminately  whether  to  contributors  or  to  non- 


FINANCES  OF  FIRE  INSURANCE  213 

contributors.  There  is  no  idea  of  profit;  no  capital 
has  been  risked  as  in  the  case  of  the  stockholders  in 
fire  insurance  companies.  The  tax  is  in  theory  levied 
upon  all  property  holders  and  income  receivers.  The 
premium  is  levied  only  upon  those  who  choose  to  become 
members  of  the  insured  group.  The  premium  is  not 
directly  apportioned  to  the  amount  of  property  held 
as  is  the  tax,  but  somewhat  according  to  the  condition 
of  the  property ;  that  is,  in  respect  to  the  hazard  of  the 
risk. 

The  premium  in  fire  insurance  as  in  life  insurance  is 
paid  in  advance ;  that  is,  it  is  paid  at  the  time  of  making 
the  contract  which  marks  the  beginning  of  the  protec- 
tion. It  is  not,  therefore,  strictly  considered,  paid  in 
advance  except  that  future  protection  is  purchased  by 
a  certain  amount  of  the  present  paid  premium.  The 
premium  is  paid  for  policies,  running  from  one  to  five 
years,  and  provision  is  made  for  short-term  rates ;  that 
is,  for  protection  covering  a  period  less  than  a  year. 
This  becomes  important  either  when  temporary  pro- 
tection is  desired  or  when  policies  are  canceled,  either 
by  the  insurer  or  the  insured,  before  the  end  of  the  period 
for  which  they  were  granted.  The  premium  is  based 
on  one  hundred  dollars'  worth  of  insurance.  In  general 
the  rate  is  lower  for  the  longer  term  contract ;  that  is,  a 
rate  of  seventy-five  cents  per  hundred  for  a  one-year 
policy  may  become  a  sixty  cent  rate  for  a  three-year 
policy.  The  following  table  shows  the  amount  of  pre- 
mium received  and  the  average  rate  by  the  joint  stock 
fire  insurance  companies  as  reported  to  the  Insurance 
Department  of  New  York  for  1914. 


2I4 


PRINCIPLES  OF  INSURANCE 


TERM  OF  CONTRACT 

AMOUNT  OP  PRE- 
MIUM 

RATE  PER  $100 

One  year  or  less      

$i8i;,7!;o,<62 

$1.0003 

Two  years      

4,177.420 

.8<C72 

Three  years    

24.7,6';^,  174 

.01  c6 

Four  years     

7.720.^8 

.9828 

Five  years      

i2o./?8i>,86^ 

1.1607 

Combined  term       

384,0  3  7,004 

.0877 

Total  business    

$<;6.oi2,8'tQ,,32Q 

$1.0189 

The  Reserve.  —  The  method  of  paying  premiums 
accounts  for  the  existence  of  the  reserve  in  fire  insur- 
ance. There  is  some  difference  of  opinion  as  to  the 
exact  character  and  purpose  of  this  fund.  It  is  called 
both  the  reinsurance  reserve  and  the  unearned  premium 
income.  Some  argue  that  it  is  simply  that  fund  which 
would  be  sufficient  to  pay  the  fire  losses  on  policies  in 
force ;  others  maintain  that  it  is  that  fund  which  would 
induce  another  company  to  assume  the  contracts  in 
force.  Before  discussing  the  implications  which  would 
result  from  the  different  theories  as  to  the  nature  of 
this  fund,  let  us  notice  more  particularly  its  origin. 
Since  the  policies  run  from  one  to  five  years  and  since 
the  premium  is  paid  in  advance,  it  is  evident  that  the 
company  holds  certain  funds  for  which  it  has  not  at  the 
particular  time  given  any  protection.  That  is,  at  the 
close  of  any  day  in  any  year  it  has  earned  one  three 
hundred  and  sixty-fifth  of  the  premium,  or  at  the  close 
of  a  month  one  twelfth  of  the  premium  on  a  one-year 
policy.  It  might  be  argued  with  some  reason  that  in 
strict  insurance  theory  this  method  of  determining  the 


FINANCES  OF  FIRE  INSURANCE  215 

amount  earned  is  not  correct  because  the  risk  is  assumed 
for  a  definite  period  and  the  cost  of  assuming  such  risk 
is  based  upon  the  occurrence  of  fire  over  a  period  of 
years.  That  is,  the  specific  premium  is  paid  not  only 
for  the  immediate  protection  granted,  but  also  for  the 
assumption  of  a  risk  in  future  time,  and  no  equating 
of  this  charge  over  a  short  period  can  be  made  since 
short-period  fluctuations  are  very  unequal.  If  all 
premiums  were  paid  on  the  basis  of  daily  or  even  monthly 
protection,  the  total  premium  charged  would  undoubtedly 
be  greater  than  it  now  is,  since  the  risk  for  the  insurer 
would  be  greater.  However,  for  practical  reasons,  such 
as  determining  the  solvency  of  companies,  their  sale 
to  other  insurers,  or  their  taxation,  some  method  must 
be  devised  for  calculating  this  reserve. 

Unearned  Premium.  —  It  is  undoubtedly  true  that 
a  part  of  this  paid  premium  is  unearned ;  that  is,  it  is 
held  by  the  company  in  trust  for  policyholders.  It  is 
in  part  at  least  a  liability  for  the  company,  since  claims 
may  arise  from  the  policyholder  either  through  losses 
by  fire  or  through  a  demand  for  a  cancellation  of  the 
policy.  A  part  of  this  fund  which  is  held  may  become, 
at  the  close  of  the  period  for  which  the  policies  were 
granted,  the  property  of  the  company.  The  protection 
has  been  given,  and  any  excess  in  the  premiums  together 
with  their  earnings  properly  constitute  the  profits  from 
the  business  for  the  shareholders  who  have  risked  their 
capital  in  the  event  the  premiums  are  not  sufficient 
to  meet  the  accrued  losses.  If  the  company  has  held  in 
this  reserve  such  funds  as  will  pay  the  holders  of  policies 
their  share  of  the  unearned  premium  on  unexpired  risks, 


216  PRINCIPLES  'OF  INSURANCE 

it  is  relieved  of  liability,  assuming  of  course  that  loss  pay- 
ments have  been  regularly  paid. 

How  much,  if  any,  of  the  assets  held  in  the  business 
on  account  of  the  existence  of  this  reserve  will  ultimately 
be  released  and  made  available  for  distribution  in  the 
form  of  dividends  to  stockholders  or  otherwise  depends 
upon  the  care  with  which  the  company  selects  risks  at 
the  particular  rate  of  premium.  Experience  shows  that 
the  losses  on  policies  are  greater  in  the  early  term  of  the 
policies.  This  is  chiefly  due  to  the  greater  prevalence 
of  moral  hazard  and  incomplete  data  as  to  the  physical 
aspects  of  the  hazard;  whereas  the  older  the  risk,  the 
less  the  percentage  of  loss,  since  the  rate  becomes  nor- 
mally a  more  accurate  expression  of  the  hazard  assumed. 
The  percentage  of  loss  therefore  on  this  unearned  pre- 
mium is  greater  in  the  earlier  than  in  the  later  period 
of  the  policy. 

It  is  impossible  to  determine  whether  the  unearned 
premium,  held  on  a  particular  risk  or  even  a  class  of  risks, 
is  at  a  particular  date  adequate  or  inadequate,  for  this 
would  assume  a  knowledge  of  the  exact  correctness  of 
the  particular  rate  or  premium.  Whether  it  is  or  is  not, 
depends  primarily  on  what  the  future  losses  will  be. 
The  premium  is  retrospective  in  its  determination ;  that 
is,  it  is  a  price  established  for  a  thing  the  cost  of  pro- 
duction of  which  cannot  be  previously  known.  Indem- 
nity is  in  the  future,  but  its  price  in  the  form  of  a  premium 
must  be  fixed  at  the  time  of  the  sale.  This  is  done,  as 
has  been  described,  by  analyzing  so  far  as  is  possible  the 
hazard  of  each  risk  in  respect  to  past  experience  and  other 
factors.  Notwithstanding  the  impossibility  of  deter- 


FINANCES  OF  FIRE  INSURANCE  217 

mining  the  specific  adequacy  of  any  particular  premium, 
there  is  a  certain  amount  of  it  which  has  not  been  earned, 
and  some  method  of  arriving  at  the  unearned  portion 
of  the  premium  is  necessary  if  any  test  of  solvency  is 
to  be  applied  to  the  company. 

How  the  Unearned  Premium  is  Determined.  —  The 
general  method  is  one  by  which  there  is  an  equation  of 
dates  or  periods  of  time.  An  annual  policy  written  on 
January  the  first  has  on  December  the  thirty-first  only 
one  day  to  run,  while  one  written  on  the  latter  date  has 
three  hundred  and  sixty-four  days  to  run.  These  two 
assumed  policies  may  be  considered  as  equating  each 
other  with  six  months  as  their  average  length  of  time  to 
run.  This  simple  hypothesis  is  applied  to  all  the  poli- 
cies for  the  year.  This  assumes  that  the  company  has 
written  business  throughout  the  year  and  in  equal 
amounts  during  each  of  the  one-half  year  periods  or  on 
the  basis  of  each  month.  Since  policies  are  written  for 
terms  longer  than  one  year,  provision  must  be  made  for 
determining  the  reserve  on  two,  three,  and  five  year 
policies.  This  is  done  by  applying  the  preceding  prin- 
ciple to  all  the  longer  term  policies  in  the  form  of  the 
rule  that  the  reinsurance  reserve  or  unearned  premium 
for  unexpired  risks  is  to  be  determined  by  taking  fifty 
per  cent  of  the  premium  received  on  all  unexpired  risks 
having  less  than  a  year  to  run  and  a  pro  rata  on  all 
risks  which  have  more  than  one  year  to  run. 

Reinsurance  Reserve.  —  Before  illustrating  the  actual 
operation  of  this  principle,  an  explanation  of  the  term 
"  reinsurance  reserve  "  is  necessary.  It  is  often  used 
synonymously  with  "  unearned  premium  fund."  But 


2l8 


PRINCIPLES  OF  INSURANCE 


these  two  funds  are  not  necessarily  the  same.  A  com- 
pany which  decided  to  reinsure  its  risks  might  well  be 
able  to  do  so  for  a  sum  less  than  its  unearned  premium 
fund.  On  the  other  hand  if  its  risks  have  been  care- 
lessly selected,  it  may  not  be  able  to  reinsure  its  business 
in  another  company  for  the  amount  held  in  this  unearned 
premium  fund.  A  fire  insurance  company  does  not 
begin  business  with  the  expectation  of  reinsuring  its 
risks.  It  does  not  need  to  collect  a  fund  for  this 
purpose.  The  state  in  supervising  the  fire  insurance 
business  of  companies  is  not  primarily  interested  in  com- 
pelling them  to  collect  a  fund  for  reinsurance.  Regu- 
lation of  assets  and  their  periodic  valuation  is  for  the 
purpose  of  determining  whether  funds  are  held  in  suffi- 
cient amount  to  meet  the  obligations  in  the  contracts. 
The  reserve  is  required  to  be  maintained  not  for  purposes 
of  reinsuring  the  business,  but  for  meeting  maturing 
policy  claims.  The  true  reserve  therefore  in  fire  insur- 
ance is,  as  in  life  insurance,  a  liability  of  the  company 
during  the  existence  of  the  policies  from  whose  advance 
premiums  it  has  been  set  aside.  The  following  tables 
illustrate  how  the  rule  for  its  calculation  is  applied  to 
the  different  length  of  policies. 


TERM  FOR  WHICH  WRITTEN 

PREMIUM 

AM'T.  EARNED  AT 
END  OF  YEAR 

i  year      .    

$1,000,000 

$500,000 

2,000,000 

500,000 

3,000,000 

500,000 

4  years     

4,000,000 

500,000 

5,000,000 

500,000 

FINANCES  OF  FIRE  INSURANCE  219 

Since  on  a  one-year  policy  fifty  per  cent  of  the  premium 
is  assumed  to  be  earned  and  fifty  per  cent  unearned,  the 
$1,000,000  premium  receipt  divides  itself  under  this 
rule  into  two  equal  amounts.  The  $500,000  unearned 
or  the  reserve  for  that  year  on  these  policies  becomes 
earned  in  the  following  year.  On  the  policies  which  run 
for  three  years  the  pro  rated  part  earned  at  the  close  of 
the  first  year  is  $500,000 ;  that  is,  one  sixth  of  it  is  earned, 
since  in  three  years  there  are  thirty-six  months  and  the 
six  month  or  fifty  per  cent  part  determined  for  one-year 
policies  is  one  sixth  of  the  thirty-six  months.  Likewise 
on  the  five-year  policies  the  amount  of  the  $5,000,000 
premium  receipt  which  has  been  earned  is  $500,000, 
since  in  five  years  there  are  sixty  months  and  six  months 
is  one  tenth  of  the  sixty  months.  It  will  be  understood 
in  using  the  ratio  of  six  months  to  the  total  number 
of  months  in  the  term  of  the  policies,  that  this  is  only 
applying  an  easy  method  of  calculating  the  unearned 
premium  by  expressing  the  fifty  per  cent  rule  in  terms 
of  months. 

The  further  application  of  this  principle  of  determin- 
ing the  unearned  premium  or  reserve  may  be  illustrated 
in  the  following  manner.  Assume  that  a  company  has 
been  in  business  three  years,  having  written  one-year, 
three-year,  and  five-year  risks.  What  would  be  the 
unearned  premium  fund  at  the  close  of  each  year  and 
the  total  amount  at  the  close  of  the  three-year  period 
of  business  ? 


220  PRINCIPLES  OF  INSURANCE 

BUSINESS  OF  1912 


TERM  OF  POLICY 


AMOUNT  OF  PRE- 
MIUM 


EARNED  PREMIUM 


i  year $100,000  50,000 

3  year 120,000  (i)     20,000 

5  year 200,000  (y1^)    20,000 

$420,000  $90,000 

BUSINESS  OF  1913 

i  year $100,000  $50,000 

3  year 120,000  20,000 

5  year 200,000  20,000 

$420,000  $90,000 

Adding  earned  premiums  on  business  of  1912  : 

On  i-year  policies  \  or $50,000 

On  3-year  policies  \\  or 40,000 

On  s-year  policies  i#  or 40,000 

$130,000 
90,000 

Total  earned  premium $220,000 

BUSINESS  OF  1914 

i  year $100,000  $50,000 

3  year 120,000  20,000 

5  year 200,000  20,000 

$90,000 

Adding  earned  premiums  on  business  of  1912 : 

On  i-year  policies 

On  3-year  policies (If)  $40,000 

On  s-year  policies (i§)    40,000 

Adding  earned  premiums  on  business  of  1913 : 

On  i-year  policies (T^)   $50,000 

On  3-year  policies (H)     40,000 

On  s-year  policies (H)     40,000 

Total  premium  earned $300,000 


FINANCES  OF  FIRE  INSURANCE  221 

It  will  be  observed  that  at  the  close  of  the  first  year 
the  company  has  earned  only  $90,000  of  the  total  pre- 
mium which  it  has  received,  the  remainder,  $330,000, 
being  set  aside  as  a  reserve  for  the  liability  incurred 
under  the  policy  contracts.  In  the  second  year  the 
company  likewise  earns  only  $90,000  of  the  business 
written  during  the  year,  but  it  has  earned  $130,000  of  the 
premiums  received  on  the  business  of  the  preceding  year, 
which  makes  a  total  of  $220,000  earned  premiums  of  a 
total  premium  receipt  during  the  two  years  of  $840,000. 
It  will  be  understood  that  in  the  second  year  it  earns 
all  the  premium  on  the  one-year  business  of  the  first 
year  and  will  therefore  be  freed  from  any  further  obliga- 
tion to  maintain  a  reserve  on  that  business.  Likewise 
in  the  fourth  year  it  will  have  earned  all  the  premium 
on  the  three-year  business  of  the  first  year ;  and  in  the 
sixth  year  all  the  premium  on  the  five-year  business  of 
the  first  year  will  have  been  earned.  It  must  not  be 
assumed  (  from  these  illustrations  that  the  company  in 
actual  operation  sets  aside  this  particular  part  of  every 
year's  premium  receipt  and  holds  it  to  pay  the  specific 
losses  in  these  policies.  From  the  total  fund  held  by 
insurance  companies,  claims  are  continually  paid  with- 
out respect  to  the  specific  sources  of  these  funds. 

Significance  of  Companies'  Reserves.  —  This  method 
of  averaging  the  reserves  is  of  value  in  determining  the 
solvency  of  companies,  but  it  should  not  be  used  to  com- 
pare the  excellence  of  companies.  Many  other  facts 
should  be  taken  into  consideration  for  this  purpose. 
The  expenses  and  the  losses  incurred,  the  interest  ob- 
tained on  the  unearned  premium,  the  surplus,  the  capital, 


222  PRINCIPLES  OF  INSURANCE 

and  many  other  factors  are  important  when  comparing 
companies.  These  reserves,  as  calculated  by  the  stat- 
utory requirements,  become  a  part  of  the  general  fund 
of  the  insurance  company.  Interest  on  invested  funds 
is  a  part  of  it.  From  this  general  fund  not  only  are 
claims  paid,  but  also  expenses,  taxes,  and  profits  or  divi- 
dends. The  true  purpose  of  the  reserve  is  to  guarantee 
the  ability  of  the  company  to  meet  its  policy  obligations. 
Disadvantages  to  New  Companies  of  This  Method.  — 
This  method  of  calculating  the  reserve  may  quite  dif- 
ferently affect  old  and  new  companies.  It  will  be  recog- 
nized that  under  this  system  a  relatively  large  amount 
of  the  premium  is  compelled  to  be  held  in  the  early 
years  of  the  company  in  this  reserve;  that  is,  a  new 
company  will  find  a  large  proportion  of  its  income  not 
available  for  paying  expenses  and  losses.  A  new  com- 
pany is  likely  to  emphasize  annual  business.  This 
business  is  often  not  as  good  as  the  term  business  of 
three  and  five  years  which  becomes  settled ;  that  is,  its 
rate  is  likely  to  be  a  truer  expression  of  the  hazard,  and 
the  expense  of  its  acquisition  is  not  so  great.  The  new 
company  is  likely  to  be  at  a  disadvantage  in  securing 
business  because  it  is  new.  The  old  company  has  from 
past  business  accumulated  a  reserve  and  probably  a 
surplus.  It,  as  well  as  the  new  company,  must  set  aside 
this  high  reserve,  but  as  compared  with  the  new  company 
it  has  old  policies  continually  expiring,  thus  setting 
free  funds  held  as  unearned  premiums.  A  new  company 
may  receive  $500,000  in  premiums  on  its  business. 
Assume  it  is  one-year  business.  It  must  set  aside 
$250,000  of  this  as  a  reserve.  Commissions  will  average 


FINANCES  OF  FIRE  INSURANCE  223 

twenty  per  cent  and  other  expenses  probably  twenty 
per  cent.  These  will  amount  to  $200,000.  The  fire 
loss  will  be  probably  fifty  per  cent  which  will  amount 
to  $250,000.  If  all  these  items  are  added,  the  total  is 
$700,000,  which  is  $200,000  in  excess  of  the  premium 
receipt.  This  is  an  apparent  loss.  But  as  a  matter 
of  fact  only  $450,000  has  been  paid  out ;  that  is,  $200,000 
for  expenses  and  $250,000  for  losses. 

This  statutory  method  of  calculating  reserves  is  in 
part  a  result  of  the  existence  of  the  conflagration  hazard, 
since  its  prevalence,  as  well  as  the  normally  fluctuating 
experience  of  companies,  does  not  produce  the  assumed 
loss  ratio  of  fifty  per  cent  for  each  company.  There  is, 
however,  no  doubt  that  the  prevalent  method  of  deter- 
mining the  reserve  places  a  very  great  handicap  upon 
the  organization  of  successful  fire  insurance  companies. 
The  greater  number  of  such  companies,  as  will  be  shown 
later,  have  been  forced  to  reinsure  their  business  or  fail. 
These  companies  are  not  only  under  disadvantage  in 
securing  a  good  class  of  business  which  would  tend  to 
make  them  successful,  but  they  are  forced  to  set  aside 
a  large  part  of  their  income.  This  is  not  available  for 
expenses  in  developing  the  business  or  for  paying  ordi- 
nary current  losses,  for  the  latter  of  which  it  is  not  needed. . 
It  is  not  probable  under  present  conditions  that  a  large 
number  of  successful  fire  insurance  companies  will  be 
formed.  This  need  not  be  considered  a  disadvantage, 
provided  there  is  sufficient  indemnity  for  sale.  It  is 
not  a  situation  in  which  the  stronger  the  competition 
and  the  greater  the  number  of  competing  units,  the 
greater  the  public  benefit. 


224  PRINCIPLES  OF  INSURANCE 

The  situation  as  determined  by  these  conditions  and 
legal  requirements  is,  however,  one  which  should  be 
known  to  the  public,  both  for  the  purpose  of  protecting 
innocent  investors  in  the  frequently  organized  new 
stock  fire  insurance  companies,  and  also  that  modifica- 
tions in  the  requirements  or  other  means  may  be  taken 
to  secure  protection  when  there  is  a  dearth. of  indemnity. 
As  the  situation  now  stands  the  chances  against  the 
formation  of  a  large  successful  stock  fire  insurance 
company  are  very  great,  if  they  are  not  indeed  prohibi- 
tive. 

The  Surplus.  —  The  surplus  in  fire  insurance  has 
greater  significance  than  in  life  insurance.  In  fire  insur- 
ance it  is  that  amount  set  aside  exclusive  of  the  required 
reserve  which  is  held  by  the  company  as  an  additional 
guarantee  to  policyholders.  It  is,  however,  the  prop- 
erty of  the  company ;  that  is,  it  is  a  proprietorship  lia- 
bility. Its  origin  is  from  the  profits  of  the  business. 
It  may  be  used  for  any  one  of  several  purposes.  Exces- 
sive losses,  due  to  a  conflagration  or  unfortunate  experi- 
ence on  certain  classes  of  business  or  in  certain  sections, 
may  be  paid  in  part  from  it.  Dividends  may  be  paid 
from  it  during  the  unprofitable  years  on  the  business. 
It  is  the  practice  of  all  strong  stock  companies  to  accu- 
mulate a  surplus.  Its  existence  may  prevent  an  assess- 
ment on  the  stockholders  at  times  of  heavy  losses.  In 
many  companies  the  surplus  exceeds  the  capital  stock. 
In  life  insurance  there  is  little  reason  to  accumulate  a 
large  surplus  since  the  loss  ratio  is  very  regular.  Its 
chief  use  is  to  protect  the  life  company  against  fluctua- 
tions in  their  interest  earnings  and  not  in  their  mor- 


FINANCES  OF  FIRE  INSURANCE  225 

tality  experience.  Dividends  in  the  stock  life  insur- 
ance companies  may  also  be  equalized  by  the  existence 
of  a  surplus.  But  fire  insurance  companies  are  sub- 
jected not  only  to  fluctuations  in  their  earnings  on  in- 
vested funds,  but,  what  is  more  important,  the  burning 
ratio  over  a  series  of  years  shows  no  such  regularity 
as  does  the  death  rate.  A  conflagration  never  occurs 
either  without  causing  a  number  of  companies  to  fail  or 
placing  a  great  strain  on  many  of  them.  The  surplus 
serves  as  a  bumper  to  receive  the  shock  of  the  heavy 
losses.  Some  companies  accumulate  a  special  confla- 
gration surplus.  The  contingencies  are  therefore  more 
numerous  and  serious  in  fire  insurance  than  in  life  in- 
surance. Hence  the  accumulation  of  a  surplus  by  the 
latter  companies.  The  amount  to  be  accumulated 
and  the  specific  additions  to  the  fund  from  year  to 
year  are  matters  of  judgment  for  the  officials  of  the 
company,  as  determined  by  the  character  of  the  busi- 
ness and  its  profitableness.  It  is  not  primarily  a 
source  for  the  extension  of  the  business,  since  not 
infrequently  stock  insurance  companies  increase  their 
capital  stock  by  the  sale  of  new  shares  of  stock. 
It  is  in  the  nature  of  a  safety  fund  which  serves  to 
guarantee  the  successful  continuance  of  the  company 
to  the  shareholders  and  also  to  give  added  protection 
to  the  policyholder. 

State  Regulation  of  Investments.  —  The  investments 
of  fire  insurance  companies  are  regulated  by  the  state 
in  somewhat  the  same  manner  as  those  of  life  insurance 
companies.  The  state  often  prescribes  the  kind  of 
securities  which  may  be  held  and  makes  a  valuation 
Q 


226  PRINCIPLES  OF  INSURANCE 

of  the  fire  insurance  companies'  assets.  But  investments 
in  fire  insurance  companies  differ  from  those  in  life 
companies  in  several  respects.  In  the  first  place,  inter- 
est accumulations  do  not  influence  the  rates  in  fire 
insurance  as  in  life  insurance.  The  life  insurance  con- 
tract is  made  for  a  long  period  of  years,  and  the  amount 
of  the  premium  is  a  resultant  of  the  mortality  rate  and 
the  interest  which  can  be  earned.  That  is,  the  assumed 
interest  rate  is  as  important  in  life  insurance  calculations 
as  the  mortality  rate.  But  in  fire  insurance  the  policies 
run  only  for  a  limited  number  of  years  and  the  amount 
of  the  premium  is  based  upon  the  hazard  of  the  risk 
or  the  probability  of  the  company  being  forced  to  pay 
the  claim  under  the  policy.  The  interest  earning,  there- 
fore, plays  but  a  small  part  in  determining  the  premium 
rate.  A  large  amount  of  quickly  available  funds  must 
be  held  by  the  fire  insurance  company  to  pay  the  current 
and  uncertain  losses.  It  therefore  has  large  cash  assets, 
large  amounts  deposited  in  banks,  and  in  quickly  real- 
izable investments,  such  as  stocks.  That  is,  the  assets 
of  a  fire  insurance  company  are  more  liquid  than  those 
of  a  life  company.  They  resemble  more  those  of  a 
bank.  The  interest  earnings  in  fire  insurance  are  of 
more  significance  to  the  shareholders  than  to  the  policy- 
holders. 

Character  of  Investments.  —  Notwithstanding  this 
necessity  to  have  on  hand  a  large  amount  of  funds  in 
cash  or  quickly  convertible  investments  to  meet  the 
fluctuating  liabilities  of  the  fire  insurance  company, 
there  remains  a  certain  amount  of  their  assets  which 
can  be  invested  in  long-time  securities,  such  as  bonds 


FINANCES  OF  FIRE  INSURANCE 


227 


and  mortgage  loans.  There  has  been  a  marked  tend- 
ency in  later  years  for  fire  insurance  companies  to 
confine  their  investments  to  stocks  and  bonds.  Mort- 
gage loans  might  bring  a  higher  interest  return,  but 
they  cannot  so  easily  be  converted  into  cash.  The 
following  table  shows  the  character  of  the  assets  of 
five  of  the  oldest  and  largest  stock  fire  insurance 
companies. 


COMPANY 

REAL 

ESTATE* 

BONDS  & 
STOCKS 

MORT- 
GAGE 
LOANS 

CASH 

AGENT'S 
BALANCES 

INT.  & 
RENT 

OTHER 

ASSETS 

X 

410,000 

18,939,550 

i.9758i8 

1.968523 

102,972 

3,664 

Y 

2,450,000 

16,840,402 

35,500 

1.223746 

1.645759 

145,752 

46,019 

Z 

728,000 

21,237,343 

394,500 

1.521667 

2.765076 

265,767 

39,816 

W 

30,724,755 

5,500 

2.161180 

2.857846 

250,635 

R 

141,013 

I3,693,  236 

164,880 

•792295 

1.007264 

109,068 

10,000 

Disbursements  of  Insurance  Companies.  —  The  dis- 
bursements of  fire  insurance  companies  are  in  the  form 
of  loss  payments,  expenses,  commissions,  taxes  and 
other  operating  charges,  and  finally  dividends  or  profits. 
Excluding  the  subject  of  rates,  much  of  the  discussion 
about  fire  insurance  has  centered  on  the  subject  of  ex- 
penses and  profits.  It  is  argued  by  many  that  both 
expenses  and  profits  are  too  high  and  that  this  is  the 
primary  cause  of  high  rates  for  fire  insurance.  The 
following  table  shows  the  relation  between  income 
and  the  different  items  of  the  disbursements  in  respect 
to  the  one  hundred  and  ninety-one  joint  stock  fire  in- 
surance companies  reporting  to  the  state  of  New  York 
for  the  year  1914. 


228  PRINCIPLES  OF  INSURANCE 

Gross  premium  charged $502,808,576 

Net  premium  earned 318,348,924 

Net  premium  written 333,647,016 

Net  losses  paid 192,098,565 

Net  losses  incurred 200,720,782 

Net  expenses   (excluding  losses  paid,   dividends,  taxes, 
remittance  to  home  office,  loss  on  sales  or  maturity 

of  ledger  assets,  decrease  in  book  value) 135,823,422 

Per  cent  of  net  losses  incurred  to  net  premiums  earned      .     .     .       63.05 
Per  cent  of  net  losses  incurred  to  net  premiums  written      .     .     .       60. 1 6 

Per  cent  of  net  expenses  to  net  premiums  earned 42.66 

Per  cent  of  net  expenses  to  net  premiums  written 40.71 

The  Expense  Element.  —  In  analyzing  this  table, 
attention  may  first  be  directed  to  the*  expense  item. 
The  expense  of  fire  insurance  companies  has  some  im- 
portant characteristics.  In  the  first  place,  the  expense 
is  an  outlay  for  a  service  or  product  the  total  cost  of 
which  cannot  be  known  at  the  time  of  the  sale.  In  the 
production  of  most  commodities,  the  total  expense  of 
their  production  is  fairly  definitely  known  in  advance 
and  the  price  at  which  the  product  is  sold  usually  covers 
at  least  this  total  expense.  But  in  fire  insurance  the 
seller  of  the  indemnity  does  not  know  at  the  time  of  the 
sale  what  it  will  ultimately  cost  him  to  supply  this 
indemnity.  A  company  may,  for  example  on  a  group 
of  three-year  policies,  pay  in  losses  during  the  first  year 
of  the  policies  all  the  premium  received.  In  the  second 
place  fire  insurance  is  conducted  as  a  retail  business, 
and  it  is  therefore  subjected  to  all  the  numerous  ex- 
penses of  a  middleman  business.  From  the  local  agent 
to  the  general  agent,  to  the  department  and  finally 
to  the  home  office  is  often  a  long  road  with  many  toll- 
takers.  In  the  third  place,  the  business  in  its  cost  as- 
pects is  affected  by  so  many  fluctuating  factors  that 


FINANCES  OF  FIRE  INSURANCE  229 

the  past  often  serves  as  an  unreliable  guide  for  the  future. 
In  the  fourth  place  the  expense  of  production  is  brought 
to  the  attention  of  the  consumer  —  the  insured  —  in  a 
very  direct  manner  because  insurance  is  itself  a  finished 
product.  It  has  no  intermediate  stages  of  production, 
and  all  costs  of  production  are  centralized  in  the  transac- 
tion of  its  purchase.  An  expense  item  of  thirty  to  fifty 
per  cent  in  the  price  seems  to  the  buyer  of  insurance  a 
large  item.  If  the  consumer  would  analyze  the  items 
in  the  price  paid  for  the  ordinary  article  in  the  market, 
he  would  often  find  an  equally  high  or  higher  percentage 
added  to  the  original  producer's  price.  From  grower 
to  consumer  represents  many  stages  in  the  production 
of  many  articles,  an  addition  having  been  made  at  each 
stage  in  the  process  of  the  goods'  ripening  for  use.  But 
in  insurance  there  are  no  stages  in  production.  The  total 
costs  are  unified  in  the  one  act  of  production  and  sale. 
Classification  of  Expense.  —  The  expenses  in  fire  in- 
surance are  of  two  general  classes.  The  fixed  expenses, 
which  include  such  items  as  salaries,  rents,  supplies, 
and  inspection  rating.  The  remaining  expenses  are  of 
a  somewhat  variable  character.  These  include  such 
items  as  commissions  and  taxes.  The  fixed  expenses 
considered  as  a  ratio  to  business  transacted  do  not  di- 
rectly increase  with  an  increase  of  the  amount  of  busi- 
ness ;  that  is,  their  character  makes  the  business  of 
fire  insurance  subject  in  a  general  way  to  the  principle 
of  increasing  returns.  But  in  an  effort  to  secure  these 
potential  economies  of  large  scale  business,  a  counter- 
acting effect  is  often  produced  in  the  actual  conduct 
of  the  business  by  an  increase  in  the  other  expenses. 


230  PRINCIPLES  OF  INSURANCE 

That  is,  the  most  direct  manner  by  which  a  company 
can  secure  more  business  is  to  offer  inducements  to 
agents  in  the  form  of  higher  commissions.  This  pro- 
cedure encourages  reckless  competition  among  companies, 
which  often  means  the  acceptance  of  poor  risks  or  risks 
at  too  low  rates.  This  in  turn  increases  the  loss  ratio. 
No  other  one  fact  shows  so  clearly  the  evils  of  competition 
of  this  character  in  the  fire  insurance  business  from  which 
the  public  is  ultimately  the  sufferer.  Competition  in 
service  and  finally  in  price  should  be  encouraged,  but 
the  competition  upon  which  the  public  has  too  often 
insisted  has  been  in  rate-making  and  in  other  aspects 
of  the  business  from  which  there  can  be  no  possible 
public  gain.  The  following  table,  adapted  from  the 
1912  Report  of  the  National  Board  of  Fire  Underwriters, 
shows  the  changes  in  the  expense  ratios. 

It  will  be  observed  from  this  table  that  there  has  been 
a  marked  increase  both  in  expenses  and  commissions 
during  the  period.  This  condition  during  the  past  few 
years  has  not  changed.  But  the  ratio  of  fixed  expenses 
has  increased  from  31.06  per  cent  to  39.75  per  cent, 
that  is,  8.69  per  cent ;  while  commissions  have  increased 
from  11.32  per  cent  to  22.05  Per  cent  or  IO-73  Per  cent. 
That  is,  commissions  have  almost  doubled  during  the 
period,  whereas  other  expenses  have  increased  about 
26  per  cent.  The  former  expenses  represent  in  a  sense 
the  operating  side  of  the  business,  and  the  latter  —  com- 
missions —  the  commercial.  The  public  is  interested  in 
both  kinds  of  expenses,  and  it  may  be  inquired  to  what 
extent  the  price  of  insurance  can  be  favorably  affected 
by  a  reduction  in  these  expenses. 


FINANCES  OF  FIRE  INSURANCE 


231 


UNITED  STATES  AND   FOREIGN  COMPANIES 


RATIO  OF 

RATIO  OF 

PREMIUM 

RATIO  OF 

RATIO  OF 

V«*AD 

NUMBER  OF 

LOSSES  TO 

CHARGED 

EXPENSE  TO 

COMMISSION 

I  t.  AK 

COMPANIES 

$100  PRE- 

ON EACH 

$100  OF 

TO  $100  OF 

MIUMS 

$100  OF 

PREMIUMS 

PREMIUMS 

RISKS 

1860-1870 

146 

58.02 

31.06 

11-32 

1871-1880 

177 

58.60 

•9432 

33-i6 

14.89 

1881-1890 

IS2 

58.97 

.9880 

35-i6 

17-95 

1891-1900 

140 

60.04 

1-0313 

36.69 

I9-25 

1901 

146 

59.10 

1.0605 

37-45 

20.76 

1902 

145 

52-48 

1.1518 

35-73 

20.28 

1903 

147 

48.61 

1.1874 

36-89 

21.31 

1904 

144 

61.78 

1.1613 

36.93 

21.22 

1905 

158 

47.89 

1.1679 

36.92 

21.45 

1906 

156 

96.80 

1.1469 

38-85 

21-45 

1907 

169 

46.42 

1.1697 

38-16 

21.22 

1908 

162 

S4-84 

1.1444 

39-24 

21.89 

1909 

163 

48.12 

1.1223 

38-50 

21.50 

1910 

175 

49-74 

1.0822 

39.16 

2I.6l 

1911 

180 

53-93 

1.0594 

39-75 

22.O5 

1860-1911 

57.85 

1-0635 

36.42 

19.11 

How  Expense  can  be  Reduced.  —  It  must  be  recog- 
nized that  there  are  only  four  ways  open  to  the  public 
to  reduce  the  cost  of  fire  insurance.  First,  by  a  reduc- 
tion of  the  fire  loss.  This  subject  is  discussed  in  a  later 
chapter.  Second,  by  a  reduction  in  fixed  expenses. 
Third,  by  a  reduction  in  commissions.  Fourth,  by  a 
reduction  in  the  taxes.  The  decrease  in  fixed  expense 
is  capable  of  most  marked  reduction  by  permitting  or 
requiring  the  companies  to  cooperate  in  inspection,  rate- 
making,  and  other  activities  connected  with  the  writing 
of  the  risk  and  the  settlement  of  the  loss.  This  necessi- 
tates adequate  supervision  by  the  state  in  order  to  pre- 


232  PRINCIPLES  OF  INSURANCE 

serve  justice  and  equity  in  rates.  But  no  amount  of 
competition  in  inspecting  and  rating  risks  will  favorably 
affect  the  price  of  insurance.  In  the  case  of  commis- 
sions, cooperation  by  companies  under  the  supervision 
of  the  state  would  also  probably  affect  the  amount  paid 
in  commissions.  This  is  not  to  argue  that  fire  insur- 
ance agents  as  a  class  are  paid  wages  higher  than  those 
for  equally  efficient  laborers  in  other  industries.  But 
in  the  actual  conduct  of  the  business,  the  wage  paid  to 
agents  as  a  commission  often  serves  to  increase  the 
price  of  the  insurance,  both  because  it  encourages  dis- 
crimination and  rate  cutting,  as  well  as  the  bringing  into 
the  business  undesirable  classes  of  agents  who  render  no 
service  commensurate  with  the  payment  received.  Uni- 
form commissions  to  properly  qualified  and  operating 
agents  would  bring  into  fire  insurance  a  much  desired 
stable  element  in  the  expense  and  would  reflect  itself 
both  in  a  more  equitably  distributed  and  in  a  lower  cost. 
The  Tax  Element  in  Expense.  —  The  fourth  source 
of  reducing  the  expense  of  fire  insurance  companies  — 
taxes  —  does  not  seem  to  offer  much  promise.  The 
taxes  vary  from  state  to  state,  not  only  as  to  the  general 
rate  levied  by  the  state  government  but  also  in  respect 
to  the  extent  that  local  governments  levy  charges  and 
licenses  upon  the  business.  In  1914  the  one  hundred 
and  ninety-one  stock  fire  insurance  companies  of  the 
state  of  New  York  paid  exclusive  of  real  estate  taxes 
$9,120,508,  in  taxes.  This  was  2.73  per  cent  of  the  net 
premiums  written,  or  6.46  per  cent  of  the  net  premiums 
earned  less  losses  incurred.  These  taxes  are  levied  for 
the  support  of  the  insurance  departments,  for  fire  depart- 


FINANCES  OF  FIRE  INSURANCE  233 

ments,  provisions  for  firemen,  and  for  other  specific 
purposes.  In  all  states  they  constitute  a  considerable 
source  of  revenue.  Since  in  no  state  is  all  the  property 
insured,  the  fire  insurance  tax  in  its  practical  operation 
becomes  a  tax  on  insured  property.  It  thus  lacks 
universality,  and  since  it  differs  from  state  to  state  and 
since  sometimes  local  governments  levy  charges,  it 
also  lacks  uniformity  both  among  the  states  and  within 
a  state.  Since  it  is  a  tax  usually  levied  on  premium 
receipts  or  on  reserves,  it  is  shifted  from  the  company 
to  the  policyholder.  It  has  been  shown  that  the  re- 
serve in  fire  insurance  as  in  life  insurance  is  essentially  a 
liability  from  the  view-point  of  the  company,  and  hence 
a  tax  upon  it  is  not  one  upon  earned  income.  It  is 
similar  to  the  tax  on  a  property  for  its  full  value  to  the 
owner  when  a  mortgage  has  been  given  for  one  half  the 
value  of  the  property.  The  chief  argument  for  the  tax 
is  its  practicability.  It  is  easy  and  inexpensive  to  col- 
lect, and  being  a  very  indirect  tax,  no  large  amount  of 
objection  is  made  to  it  by  the  public.  If  the  proceeds 
of  the  tax  could  be  used  for  the  expenses  of  maintain- 
ing insurance  departments,  fire  departments,  and  other 
activities  directly  benefiting  property  owners,  it  would 
have  some  justification  on  the  basis  of  the  fee  theory  of 
a  public  revenue.  But  even  under  these  circumstances 
the  property  not  insured  and  those  not  owning  property 
would  also  derive  benefits.  If  the  tax  was  so  devised 
as  to  make  the  profits  alone  a  direct  source  of  revenue 
to  the  state  treasury,  as  contrasted  with  that  amount 
collected  for  the  supervision  work  of  insurance  and  fire 
departments,  no  especial  objection  could  be  made,  inas- 


234  PRINCIPLES  OF  INSURANCE 

much  as  the  fire  insurance  business  is  a  private  business 
in  which  capitalists  invest,  as  in  other  such  business, 
with  the  expectation  of  receiving  a  profit.  In  this 
respect  it  would  seem  that  a  tax  is  as  justifiable  on  the 
profits  of  insurance  as  upon  the  profits  of  any  other 
business.  What  is  most  needed  in  fire  insurance  taxa- 
tion is  greater  uniformity.  With  the  varying  rates 
from  state  to  state,  property  owners  in  one  state  are 
compelled  to  pay  the  tax  levied  in  another  state.  There 
is,  however,  an  increasing  tendency  to  add  the  tax,  es- 
pecially the  local  government  tax,  to  the  regular  rate, 
as  determined  by  the  hazard  of  the  risk.  A  program  of 
insurance  taxation  which  would  redound  to  the  benefit 
of  the  public  and  at  the  same  time  meet  the  demands 
of  most  insurance  companies  would  be  as  follows : 

First.    An  equitable  system  of  uniform  taxation. 

Second.  A  repeal  of  all  laws,  which  authorize  counties  and 
municipal  corporations  to  tax  premium  incomes  as  an  item  of  local 
property. 

Third.  A  repeal  of  all  laws  which  authorize  local  governments 
to  levy  occupation  or  license  taxes. 

Fourth.  A  tax  on  net  premium  receipts  by  the  state,  sufficient 
to  support  the  insurance  department. 

If  reference  is  made  to  the  tables  on  pages  228  and  231, 
it  will  be  observed  that  the  expenses  of  fire  insurance 
companies  are  about  thirty-eight  cents  out  of  every 
dollar  received.  Of  this  thirty-eight  cents,  about 
twenty-one  cents  are  for  commissions  and  2.73  cents 
for  taxes.  The  losses  require  about  fifty-seven  cents 
of  this  dollar.  There  remains  five  cents  for  profit. 
This  refers  to  the  average  results  and  not  to  the  results 


FINANCES  OF  FIRE  INSURANCE  235 

of  any  particular  year  in  which  the  total  disbursements 
of  any  one  company  may  exceed  the  receipts,  or  be  well 
within  them. 

Dividend  and  Profits.  —  The  subject  of  dividends 
or  profits  in  the  fire  insurance  business  remains  for  final 
consideration  in  this  discussion  of  the  finances  of  the 
business.  In  the  first  place,  it  is  necessary  to  define 
what  is  meant  by  the  profit  in  the  business  of  fire  insur- 
ance and  to  understand  the  source  of  it.  The  stock 
fire  insurance  company  has  two  sources  of  income 
out  of  which  profit  may  be  paid. 

Source  of  Profit.  —  First,  the  net  profit  on  the  indem- 
nity sold ;  that  is,  an  excess  for  example  in  the  premiums 
on  one-year  policies  over  the  losses  paid  on  such  risks 
and  all  the  expenses  connected  with  them.  This  net 
profit  in  premiums  received  over  losses  and  expenses 
paid  incident  to  the  business  may  be  called  the  net 
underwriting  profit. 

Second,  the  interest  on  invested  funds.  This  interest 
arises  from  two  kinds  of  funds.  First,  the  interest  on 
funds  paid  in  by  policyholders  for  protection  which  is 
in  the  course  of  being  earned.  This  is  the  unearned 
premium  reserve.  Second,  the  capital  stock  and  the 
surplus,  which  is  the  property  of  the  stockholders, 
the  first  having  been  originally  contributed  by  stock- 
holders at  the  time  the  company  was  organized  and  the 
second  having  been  set  aside  from  past  earnings.  Both 
capital  stock  and  surplus  are  potentially  sources  for 
the  payment  of  losses,  but  they  are  directly  the  property 
of  the  stockholders  and  not  of  the  policyholders,  as  is 
the  reserve  or  unearned  premium. 


236  PRINCIPLES  OF  INSURANCE 

Underwriting  and  Gross  Profit.  —  In  order  to  calcu- 
late the  trade  profit,  a  distinction  must  be  made  between 
the  true  underwriting  profit  and  the  gross  profit.  The 
trade  profit  is  determined  by  taking  the  premiums  earned 
during  the  year  and  then  deducting  the  expenses  and 
losses  incurred  during  the  year.  To  this  is  added  the 
interest  earned  during  the  year,  at  the  average  rate 
received  during  the  time  on  the  unearned  premium 
fund,  first  deducting  from  it  the  unpaid  premiums. 
Practically  all  of  the  interest  earned  on  the  assets  of 
the  company,  and  especially  that  on  the  surplus,  is 
trade  profit,  excluding  of  course  the  interest  earned  on 
the  capital  stock.  This  is  true,  because  in  fire  insurance 
as  contrasted  with  life  insurance  the  item  of  interest 
earning  is  not  primarily  considered  in  determining  rates. 
However,  since  the  net  surplus  represents  the  accumula- 
tions of  past  years,  the  interest  earning  on  it  should  not 
be  considered  in  determining  the  trade  profits  of  a  single 
year. 

Rules  for  Determining  the  Profit  of  a  Company.  — 
Since  insurance  policies  are  written  for  other  than  one- 
year  periods,  the  reports  which  show  the  percentage 
of  incurred  losses  and  expenses  to  premium  receipts 
on  an  annual  basis  should  not  be  interpreted  to  prove 
completely  the  prosperity  or  lack  of  prosperity  of  the 
company.  Inquiry  must  be  made  as  to  whether  the 
losses  reported  are  for  losses  incurred  or  losses  paid. 
Premiums  and  losses  for  a  year  disclose  but  little  im- 
portant information  as  to  the  real  condition  of  the 
company.  Premiums  are  not  chiefly  received  for  one- 
year  contracts.  Only  that  portion  of  the  premiums  which 


FINANCES  OF  FIRE  INSURANCE  237 

has  been  earned  belongs  to  the  company.  Nor  is  the 
percentage  of  fire  loss  to  unearned  premiums  a  satis- 
factory test  of  comparison.  This  could  be  used  only  of 
companies  of  five  or  more  years'  experience  in  business 
which  have  had  a  steady  and  even  volume  of  business. 
Warning  needs  also  to  be  given  against  a  ready  accept- 
ance of  statistics  which  seek  to  show  that  the  fire  insur- 
ance business  is  not  and  never  has  been  a  successful 
business  from  the  standpoint  of  the  investor.  Such  re- 
ports and  statistics  usually  include  the  experience  of  all 
companies,  thus  embracing  those  dishonestly  managed 
and  those  inefficiently  operated.  If  a  similar  tabulation 
were  made  of  almost  any  business,  it  could  probably  be 
shown  that  it  had  proven  a  failure.  Pure  profit  in  a 
competitive  business  is  a  differential  return  which  tends 
to  disappear,  and  from  its  very  nature  cannot  be  se- 
cured by  all  the  units  in  the  business.  It  is  safe  to  say 
that  capital  in  the  fire  insurance  business  has,  at  least 
in  the  successful  companies,  enjoyed  a  normal  return. 
Otherwise  it  would  have  left  the  business  and  new  capital 
would  have  refused  to  enter.  It  is  doubtless  true  that 
new  capital  has  been  attracted  to  the  business  which 
the  possibilities  of  securing  a  return  did  not  warrant,  and 
it  is  to  this  phase  of  the  question  that  our  discussion 
is  now  directed. 

Has  Fire  Insurance  been  Extremely  Profitable  ?  — 
It  has  long  been  a  popular  belief  that  the  business  of 
fire  insurance  is  very  profitable  to  those  engaged  in  it. 
Nor  is  the  belief  confined  to  the  uninformed  classes. 
It  is  frequently  held  by  the  business  classes,  legislators, 
and  others  whose  general  information  make  them  intel- 


238  PRINCIPLES  OF  INSURANCE 

ligent  on  most  questions.  It  is  submitted  that  the 
above  statement  is  not  a  mere  assertion,  but  that  the 
evidence  of  the  existence  of  this  belief  is  found  in  cer- 
tain facts.  In  the  first  place,  there  are  but  few  examples 
of  legislatures  which  are  not  ready  to  welcome  any  new 
method  of  taxing  the  stock  fire  insurance  companies  or 
increasing  present  taxes.  Such  companies  are  usually 
foreign ;  that  is,  they  are  chartered  in  another  state  or 
they  are  foreign  companies.  As  foreign  institutions 
they  come  under  suspicion  as  strangers  or  at  least  of 
deserving  no  such  consideration  as  would  be  granted 
to  a  home  institution  or  to  a  member  of  one's  own  group. 
These  companies  seem  to  be  the  means  of  "  taking 
money  out  of  the  state,"  and  therefore  any  of  the  money 
which  can  "  be  kept  at  home  "  by  taxation  represents 
so  much  clear  gain.  It  is  an  interesting  example  of  the 
persistent  survival  of  the  ideas  of  the  tribal  society, 
when  a  stranger  usually  meant  an  enemy.  Special 
laws  for  the  taxation  of  insurance  companies  are  in 
existence  in  practically  every  state,  and  usually  a  dis- 
tinction is  made  between  domestic  and  foreign  com- 
panies. In  the  second  place  this  belief  in  the  excessive 
profits  of  fire  insurance  business  is  indicated  by  the 
numerous  new  companies  which  are  organized.  The 
following  table  shows  the  number  of  companies  organ- 
ized during  different  periods  and  their  assets  as  of  1914. 
A  study  of  this  table  discloses  several  important 
facts.  In  the  first  place  eighty-four  of  the  two  hundred 
and  twelve  companies  in  existence,  or  practically  forty 
per  cent,  have  been  organized  since  1900.  If  the  period 
1890  to  1914  is  taken,  that  is,  twenty-five  years,  forty- 


FINANCES  OF  FIRE  INSURANCE 


239 


eight  per  cent  of  the  companies  doing  business  in  1914 
had  been  organized  during  this  period.  In  the  second 
place  comparatively  few  companies  of  those  now  in 
business  were  organized  between  the  years  1870  to  1900. 
The  succeeding  table  of  failed  and  retired  companies 
explains  this  fact,  interpreted  in  the  light  of  the  past  dis- 
cussion of  rate-cutting  and  legislation  of  this  period. 


i 

ASSETS 

DATE  OF 

| 

a 

o    8 

0        0 

8 

ORGANIZATION 

s* 

8    8 

§0 

8    ° 

8    8 

0        0 

«       n- 

o      o" 

«J  a 

a  o 

ti  °- 

o"4-1  n 

-3  °- 

o_o  o" 

§3  8 

§3  8 

§o  o 
*»  o 

§38 

£§ 

5  * 

8         8 

8    8 

8     ° 

o 

o 

-     o" 

20 

M              C-4 

w        w 

N            10 

M           W 

Before  1850 

29 

I 

3 

4 

4 

5 

6 

4 

2 

1850-1869  . 

So 

3 

6 

9 

12 

II 

4 

3 

2 

1870-1879  . 

IS 

5 

3 

3 

I 

I 

I 

I 

1880-1889  . 

16 

i 

2 

4 

2 

6 

X 

1890-1899  . 

18 

i 

6 

4 

5 

!(<*) 

i  (c) 

1900-1914  . 

84 

9 

IS 

3S 

12 

9 

3(6) 

i  (o) 

Totals     .    .    . 

212 

ii 

21 

S9 

34 

39 

21 

12 

IO 

s 

In  the  third  place  practically  all  of  the  strongest 
companies,  as  measured  by  assets,  which  are  now  doing 
business  were  organized  prior  to  1880.  The  company 
designated  in  the  table  i  (a)  was  a  consolidation  of  two  old 
and  strong  companies.  Of  the  companies  designated 
3(6),  one  was  organized  by  another  old  company  with 
large  assets  to  take  over  a  part  of  its  business,  one 
transacts  only  a  marine  business  since  1901,  having 
reinsured  its  fire  business  in  another  old  and  strong 
company.  The  remaining  company  with  assets  over  ten 
million  dollars  was  organized  since  1900. 

The  companies  designated  i(J)  and  i(c),  organized  in 
the  decade  1890-1899,  were  in  both  cases  consolidations 


240 

of  two  old  and  strong  companies.  It  may  be  said,  there- 
fore, that,  with  one  single  exception,  all  the  fire  insur- 
ance companies  with  large  assets  are  old  companies; 
or  in  other  words,  that  the  chances  of  organizing  a  large, 
successful  fire  insurance  company,  as  disclosed  by  the 
experience  of  the  past,  are  decidedly  unfavorable. 

Failure  of  Companies.  —  What  has  been  the  experi- 
ence in  organizing  companies?  The  following  table 
shows  the  companies  that  have  failed  or  retired.  This 
fact  may  be  taken  as  a  general  index  of  success  in 
establishing  the  business. 

FAILED  OR  RETIRED  FIRE  INSURANCE    COMPANIES 

Before  1850 26 

1850-1869 132   - 

1870-1879 353 

1880-1889 229 

1890-1899 708 

1900-1914 "897 

This  shows  that  two  thousand  three  hundred  and  forty- 
five  fire  insurance  companies  have  either  failed  or  re- 
tired or  that  only  about  ten  per  cent  of  the  fire  insurance 
companies  which  have  been  organized  have  continued 
in  business.  If  an  explanation  of  the  results  shown  in 
these  two  tables  is  sought,  which  is  but  explaining  what 
the  nature  of  the  handicaps  are  that  rest  upon  a  new 
company,  the  following  facts  are  important. 

Causes  of  Failure.  —  First,  the  failure  of  new  com- 
panies to  set  aside  sufficient  funds  as  a  surplus.  A 
large  capital  is  required  to  secure  business  and  provide 
the  expenses  of  organization  and  development.  In 
the  earlier  days  there  were  either  no  unearned  premium 


FINANCES  OF  FIRE  INSURANCE  241 

reserve  laws,  or  if  they  existed,  they  were  less  stringent 
than  those  now  in  force.  The  reserves  were  estimated 
by  the  officers  of  the  company.  The  absence  of  other 
regulatory  provision  made  it  possible  for  the  company 
to  use  to  the  fullest  extent  their  available  funds.  The 
present  method  of  calculating  reserves  in  its  effect  on 
new  companies  has  been  previously  discussed. 

A  second  disadvantage  to  a  new  company  is  the  in- 
crease in  the  expense  ratio.  This  has  been  shown  in  a 
previous  table.  Not  only  have  commissions  increased 
during  the  past  fifty  years,  but  also  taxes,  rents,  and 
other  overhead  charges. 

A  third  difficulty  of  a  new  company  is  to  secure  a 
proper  agency  force.  The  old  company  has  an  enor- 
mous advantage,  both  from  the  standpoint  of  the  agent 
and  the  property  holder  who  is  seeking  insurance.  The 
new  company  may  seek  to  get  business  by  offering  higher 
commissions.  It  is  not  unlikely  to  accept  a  poorer 
grade  of  risks  in  an  effort  to  get  business  on  its  books, 
for  the  fixed  expenses  go  on  either  with  a  small  or  with 
a  moderately  large  business. 

A  fourth  difficulty  is  the  lower  level  of  rates  which 
now  prevail  as  compared  to  the  earlier  period.  Com- 
petition and  regulation  have  forced  rates  to  low  and 
often  to  unprofitable  levels. 

A  fifth  disadvantage  is  that  resulting  from  a  confla- 
gration in  the  early  life  of  the  new  company  before  it 
has  had  time  to  accumulate  a  surplus.  Few  investors 
can  be  persuaded  to  set  aside  large  funds  in  the  purchase 
of  capital  stock  in  a  fire  insurance  company  to  serve 
as  a  surplus  for  the  company  which  cannot  pay  any 


242  PRINCIPLES  OF  INSURANCE 

considerable  dividend  on  the  stock  for  a  number  of 
years.  They  prefer  to  loan  their  capital  themselves 
at  a  safe  rate  of  interest  or  to  place  it  in  those  invest- 
ments where  there  is  a  prospect  of  a  more  than  normal 
return.  If  a  conflagration  occurs,  "it  may  take  all  the 
small  surplus  and  capital  as  well  as  making  necessary 
an  assessment  on  the  shareholders  to  pay  the  losses. 

The  most  available  business  for  a  new  company  is 
likely  to  be :  first,  risks  in  congested  districts  of  large 
cities  where  there  is  often  a  deficiency  in  the  supply 
of  insurance,  but  which  by  its  very  character  has  an 
element  of  great  danger  in  it  for  the  new  company; 
and  second,  the  short-term  business  of  a  year  or  less 
which  brings  with  it  a  high  ratio  of  expense.  It  is  the 
business  which  becomes  seasoned  that  is  most  profitable 
for  the  fire  insurance  company.  The  hazards  of  all 
kinds  become  better  known  and  the  rate  is  adjusted  if 
necessary  to  measure  them. 

Dividends  of  Stock  Fire  Insurance  Companies.  - 
The  following  table  shows  for  the  period  1890  to  1914 
the  average  dividends  paid  by  the  fire  insurance  com- 
panies and  the  number  which  paid  dividends.  It  would 
seem  upon  a  casual  examination  of  this  table  that  the 
business  has  been  profitable  to  a  marked  degree.  Statis- 
tics of  the  dividends  declared  by  a  single  company,  which 
often  exceed  any  rate  shown  in  the  preceding  table,  are 
often  quoted  to  the  public  or  prospective  investors  to 
prove  that  the  business  of  fire  insurance  has  been  profit- 
able and  offers  a  good  investment.  However,  in  addition 
to  what  has  previously  been  stated  regarding  the  failure 
and  success  of  new  companies,  the  following  facts  must 
be  considered. 


FINANCES  OF  FIRE  INSURANCE 

DIVIDENDS  OF  STOCK  FIRE   COMPANIES 


243 


NUMBER  PAYING 
DIVIDENDS 

NUMBER  NOT  PAYING 

RATIO  OF  DIVIDENDS 
TO  CAPITAL 

1890 

100 

7 

1891 

98 

9 

11.05 

1892 

too 

9 

10.51 

1893 

97 

ii 

10.43 

1894 

101 

7 

10.60 

1895 

106 

6 

11.40 

1896 

1  08 

5 

11.24 

1897 

108 

ii 

"•33 

1898 

114 

6 

11.64 

1899 

114 

8 

11.65 

1900 

108 

12 

ii.  18 

1901 

no 

16 

11.63 

1902 

115 

15 

11.90 

1903 

117 

IS 

12.69 

1904 

117 

18 

13-37 

1905 

119 

24 

13.01 

1906 

127 

21 

10.97 

1907 

123 

32 

11.67 

1908 

142 

17 

I3-I7 

1909 

146 

24 

14.27 

1910 

155 

21 

16.95 

1911 

153 

29 

15-75 

1912 

156 

35 

16.00 

1913 

160 

44 

15.26 

1914 

169 

So 

15-43 

The  capital  of  a  fire  insurance  company  is  often  only 
a  small  amount  in  comparison  to  the  accumulated  assets. 
This  capital  has  often  received  no  dividends  for  a  period 
of  years.  A  surplus  has  been  set  aside  by  the  stock- 
holders instead  of  using  it  to  declare  dividends.  A  one 
per  cent  earning  on  the  total  surplus  may  express  itself 
as  a  ten  or  twenty  per  cent  earning  on  capital.  This 
surplus  and  capital  are  both  at  risk  in  the  event  of 


244  PRINCIPLES  OF  INSURANCE 

excessive  losses.    The  unearned  premium  reserve  must 
at  all  times  be  kept  intact. 

Summary.  —  From  this  survey  of  fire  insurance  as 
an  investment  several  deductions  seem  to  be  war- 
ranted :  first,  the  returns  on  the  investment  as  a  whole 
have  not  been  large.  Some  companies  have  had  suc- 
cessful careers  in  this  respect.  Many  of  them  have 
had  alternate  periods  of  success  and  failure.  Most  of 
them  have  failed.  Second,  it  is  not  impossible  to  es- 
tablish a  'Successful  new  company,  but  if  it  is  to  be  done, 
the  investors  should  expect  to  contribute  a  large  capital 
in  order  to  begin  business  with  a  considerable  initial 
surplus.  They  should  expect  to  wait  a  period  of  years 
before  any  dividend  is  declared.  Third,  the  popular 
opinion  as  to  large  profits  and  the  frequent  appeal  based 
upon  it  by  salesmen  of  fire  insurance  stock  to  investors 
to  purchase  stock  in  new  fire  insurance  companies  is  not 
justified  by  an  examination  and  analysis  of  the  actual 
experience  of  such  companies  in  the  United  States. 

REFERENCES 

The  Business  of  Insurance,  Vols.  I  and  III. 

Yale  Readings  in  Insurance  (Fire),  Chaps.  X  and  XII. 

The  Insurance  Year  Book  (Fire  and  Marine),  1914. 

Report  of  the  Illinois  Fire  Commission,  191 1. 

Report  of  the  Joint  Committee  of  the  Senate  and  Assembly  of 

New  York,  1911. 

Property  Insurance,  Chap.  XIV.     Solomon  S.  Huebner. 
Proceedings  of  the  National  Board  of  Fire  Underwriters,  1912, 

1913,  1914. 

Insurance  and  the  State,  Chap.  V.    W.  F.  Gephart. 
New  York  Insurance  Report,  1914,  Part  I,  Fire  and  Marine. 


CHAPTER  XI 

FIRE   PREVENTION   AND   THE   FIRE   LOSS 

The  Fire  Loss.  —  The  statistics  of  the  fire  loss  in  the 
United  States  show  that  $5,866,981,025  worth  of  property 
has  been  destroyed  during  the  period  1877  to  1915. 
This  does  not  represent  the  actual  loss,  since  these 
statistics  refer  only  to  the  reported  losses  on  buildings 
and  contents.  Many  small  losses  on  uninsured  property 
as  well  as  losses  of  natural  resources,  as  in  the  case  of 
forest  fires,  are  not  included.  In  general,  the  reported 
losses  mean  that  on  the  average  a  quarter  of  a  billion 
dollars  worth  of  property  is  annually  destroyed;  that 
is,  a  half  million  a  day  or  thirty  thousand  dollars  worth 
of  property  every  hour  of  every  day  in  the  year.  Nor 
does  this  enormous  loss  show  any  marked  indication  of 
a  decrease.  Reference  to  the  preceding  table  on  page  88 
will  show  that  there  has  been  on  the  contrary  an  increase 
throughout  the  period. 

Its  Economic  Significance.  —  This  loss  is  often 
designated  "  the  fire  waste "  and  very  properly  so, 
both  because  the  capital,  represented  by  the  buildings 
and  their  contents,  is  a  complete  destruction  and  also 
because  a  larger  part  of  it  can  be  prevented.  The 
insurance  money  paid  by  the  company  represents  a  tax 
or  burden  on  productive  enterprise  which  has  no  pro- 
ductive action  or  credit  to  equalize  the  liability.  It  is 

245 


246  PRINCIPLES  OF  INSURANCE 

a  real  loss  which  because  of  its  regularity  in  this  country 
has  come  to  be  considered  as  inevitable.  But  fires,  like 
death  and  disease,  if  not  absolutely  preventable,  can  be 
both  reduced  and  prevented.  Untimely  death  and 
disease  have  become  matters  of  great  concern  to  the 
people  of  this  country,  and  well-directed  efforts  are  put 
forth  to  control  them.  If  corresponding  interest  and 
activity  could  be  aroused  to  prevent  fires,  the  results 
would  be  equally  gratifying.  Not  only  is  a  vast  and 
unnecessary  amount  of  property  destroyed,  but  also  a 
large  number  of  lives.  There  are  other  losses,  such  as 
those  represented  by  the  interruptions  to  business  ac- 
tivity of  those  whose  property  is  destroyed  and  those 
with  whom  they  transact  business.  In  addition  any 
complete  estimate  of  the  cost  to  society  of  the  fire  loss 
should  include  the  large  sums  spent  to  equip  and  main- 
tain fire  departments,  waterworks  or  that  part  of  them 
used  for  fire  fighting,  fire  prevention  bureaus,  and  the 
numerous  other  agencies,  private  and  public,  which  seek 
to  control  the  loss  by  fire. 

The  following  tables,  based  upon  an  investigation  by 
the  Federal  Government,  show  the  losses  on  different 
kinds  of  buildings  in  cities  and  rural  districts  and  in 
different  political  subdivisions. 

This  per  capita  loss  equals  or  exceeds  in  many  cases 
the  local  tax  rate  levied  in  these  communities.  It  is 
impossible  to  determine  how  much  of  the  total  loss  is 
due  to  the  spread  of  fire  from  the  building  of  origin  to 
surrounding  buildings,  but  it  has  been  estimated  that  at 
least  twenty-five  per  cent  is  due  to  this  cause,  that  is,  to 
exposure.  This  exposure  loss  arises  largely  from  the 


FIRE  PREVENTION  AND   THE   FIRE  LOSS     247 


numerous  frame  buildings.  In  Europe  where  fireproof 
construction  is  the  rule,  the  loss  from  exposure  is  much 
less ;  that  is,  the  fire  is  usually  confined  to  the  building  of 
its  origin  and  frequently  to  the  particular  part  of  the 
building  in  which  it  originates.  It  will  be  observed  that 
the  table  showed  only  a  loss  of  $68,425,267  on  brick 
buildings,  whereas  the  loss  on  frame  buildings  was 
$146,659,442. 

TABLE   I. —  FIRE   LOSSES   IN  THE   UNITED   STATES   FOR 

1907 

(Statistics  gathered  by  the  United  States  Geological  Survey) 


TOTAL 

URBAN 

RURAL 

Total  fire  loss     

$2  1?  ,084,700 

$107,093,283 

$107,001,426 

Buildings    .../.. 

100,116,804 

10,173,62? 

18,083,260 

Contents    

101,027,811 

16,019,118 

49,008,157 

Brick,  etc.,  buildings  .    .    . 

68,425,267 

48,908,744 

19,516,523 

Buildings        

21,002  687 

10,816,474 

11,276,213 

Contents    ...... 

37,332,180 

20,002,270 

8,240,310 

Frame  buildings      .... 

146,659,442 

58,184,539 

88,474,903 

Buildings  

78,064,207 

20.3^7,  ici 

47,707,016 

68,101,231 

27,827,388 

40,767,847 

Number  of  fires      .... 

165,257 

105,406 

59,851 

Number  of  fires  in  brick, 
etc.,  buildings      .    .    . 
Number  of  fires  in  frame 
buildings     

36,140 

I  2O  117 

25,297 

80.100 

10,843 
40,008 

Loss  per  capita  

2.11 

2.14 

2.40 

The  total  urban  loss  was  about  the  same  as  the  loss 
in  rural  districts,,  notwithstanding  the  larger  and  con- 
gested property  values  in  the  cities.  On  the  one  hand, 


248  PRINCIPLES  OF  INSURANCE 

the  city  has  the  congestion  of  buildings  and  contents 
value  with  a  large  element  of  exposure  hazard  to  account 
for  the  large  loss,  while  rural  districts  have  little  con- 
gestion, practically  no  exposure  hazard,  but  no  efficient 
fire  departments  and  waterworks  to  reduce  the  loss. 
A  further  analysis  of  the  table  will  show  that  the  losses 
in  the  cities  are  kept  down  to  a  large  extent  by  the  ex- 
cellent fire  departments.  It  is  said  that  the  United 
States  has  the  best  fire  departments  in  the  world,  and 
they  need  to  be,  in  view  of  the  enormous  hazard  of  fire 
in  the  American  city. 

The  loss  by  conflagrations  has  already  been  discussed, 
but  it  may  again  be  emphatically  stated  that,  notwith- 
standing these  excellent  fire  departments,  no  American 
city  or  village  is  free  from  the  possibility  of  their  occur- 
rence. Fire  traps  are  present  in  every  city.  There  are 
buildings  of  poor  construction,  of  large  area  without  fire 
cut-offs,  with  unprotected  windows  and  openings  between 
floors,  and  with  combustible  contents  and  fire-producing 
processes  which  breed  conflagrations.  Fire  once  started 
in  such  buildings  spreads  rapidly  through  them  and  to 
adjoining  buildings,  thus  starting  a  conflagration  which 
the  best  fire  department  with  the  most  complete  water 
supply  is  powerless  to  control. 

The  fire  loss  in  European  countries  and  cities  is,  for 
reasons  to  be  discussed  later,  much  less  than  in  America, 
as  is  shown  by  the  following  tables. 

This  per  capita  loss  of  thirty-three  cents  in  these 
European  countries  is  to  be  compared  to  the  $2.51  per 
capita  loss  in  the  United  States,  as  shown  by  the  statis- 
tics in  the  following  table : 


FIRE  PREVENTION  AND  THE  FIRE  LOSS    249 


FIRE  LOSSES  — SIX  EUROPEAN  COUNTRIES 
(National  Board  of  Fire  Underwriters) 


COUNTRY 

YEARS 

ANNUAL 
AVERAGE 

POPULATION, 
1901 

Loss  PER 
CAPITA 

Austria  .... 
Denmark  .  .  . 
France  .... 
Germany  .  .  . 
Italy 

1898-1902 

IQOI 

1900-1904 
1901-1904 
IQOI—  1  004. 

$7,601,389 
660,924 
11,699,275 
27,655,600 

4.,112,72'C 

26,150,597 
2,588,919 
38,595,500 
56,367,178 

•22  AAQ   7CA 

$.29 
.26 
•30 
•49 

12 

Switzerland  .  .  . 

1901-1903 

999,364 

3,325,023 

Average  loss  per  capita 


The  following  table  shows  a  comparison  of  the  losses 
in  European  and  American  cities  of  somewhat  equal 
population. 

(Statistics  gathered  by  Geological  Survey  and  Bureau  of  Manufactures. 
Each  of  the  foreign  cities  is  compared  with  the  American  city  marked 
by  the  same  numeral.) 

EUROPEAN  LOSSES   FOR   1904 


Crrv 

POPULATION 

FIRE  Loss 

Loss  PER 
CAPITA 

i.  Paris,  France     

2  714  068 

$i  266  282 

$0.4.7 

2.   Frankfort,  Germany   

^24,sOO 

00,4.02 

.11 

3.   St.  Petersburg,  Russia     .... 
4.   Birmingham,  England     .... 
5.   Sheffield,  England       

I,5OO,OOO 
550,000 
426,686 

2,128,541 
226,506 
7<C,o8o 

1.42 
.41 
.18 

6.  Toulon,  France       

IOI,6o2 

ee,7Qi 

.ce 

7.   Bremen,  Germany       

2O1  84.7 

78,172 

.18 

8.  Molenbeck,  Belgium  

6^,678 

106,1^0 

1.67 

9.  Laiken,  Belgium     

11,121 

22,140 

.72 

10.   Etterbeck,  Belgium     

21.002 

IQ.sOA 

.81 

250 


PRINCIPLES  OF  INSURANCE 


UNITED    STATES   LOSSES   FOR    1907 


CITY 

POPULATION 

FIRE  Loss 

Loss  PER 
CAPITA 

i.   Chicago,  111.       

2,o4Q,i8t; 

$3,  Q37,io<; 

$1.43 

2.   Cincinnati,  Ohio     

34=;,  230 

1,971,217 

5.7O 

3.   Philadelphia,  Pa  

i,  44.1,  7  3<; 

2,003,  =522 

I.AC 

4.   Baltimore,  Md  

^3,660 

016,603 

1.66 

5.   Cleveland,  Ohio      

460,000 

=;ii;,IQ4 

1.  12 

6.  Atlanta,  Ga  

104,084 

22=1,237 

2.IS 

7.   St.  Paul,  Minn  

204  ooo 

^22,447 

2.^6 

8.   Evansville,  Ind  

6^,CK7 

196,702 

3.08 

9    Oshkosh,  Wis  

11  OH 

8o,5OO 

2.^0 

10.  Easton,  Pa  

2<,  2  ^8 

32,O73 

1.27 

A  comparison  of  the  cost  of  maintaining  fire  depart- 
ments in  European  and  American  cities  shows  that  in 
the  former  cities  it  is  about  twenty  cents  per  capita, 
while  in  the  United  States  it  was  (1907)  one  dollar  and 
fifty-three  cents  per  capita.  Thus  not  only  is  the  per 
capita  actual  loss  by  fire  seven  times  as  great  in  American 
cities,  but  the  cost  of  fire  departments  is  also  about  seven 
times  as  great  as  in  European  cities.  If  conditions  in 
this  country  were  similar  to  those  in  Europe,  there  would 
be  this  twofold  source  of  saving;  that  is,  in  the  lower 
actual  loss  and  in  the  reduced  outlay  for  fire  departments 
and  other  public  methods  of  controlling  fires. 

Causes  of  the  Fire  Loss.  —  Such  is  the  statement  of 
the  facts  of  the  fire  loss  in  the  United  States.  It  may 
now  be  inquired  what  are  the  causes  of  the  loss. 
These  causes  may  be  classified  as : 

(a)  Type  of  construction,  including  not  only  the 
character  of  the  material,  but  also  the  method  of  building. 


FIRE  PREVENTION  AND  THE   FIRE  LOSS     251 

(&)  The  theory  of  personal  responsibility. 

(c)  The   theory   of   fire   insurance   as   expressed   in 
regulatory  laws. 

(d)  Overinsurance. 

(e)  Arson  and  incendiarism. 

Construction  and  the  Fire  Loss.  —  (a)  The  large  loss 
by  fire  in  the  United  States  is  primarily  due  to  poor  and 
defective  construction  of  buildings  and  equipment.  The 
most  important  factor  in  this  is  the  predominance  of 
frame  buildings.  In  European  cities  such  buildings  are 
prohibited  in  the  cities  except  that  occasionally  frame 
sheds  or  non-permanent  parts  of  a  building  are  infre- 
quently found.  Lumber  in  most  cases  is  not  hi  Europe 
the  cheaper  building  material.  The  buildings  are  of 
brick,  stone,  or  other  fire-resisting  material,  and  in  ad- 
dition are  built  under  very  strict  inspection  both  as  to 
original  construction  and  use.  In  addition  in  many 
cases  insurance  is  compulsory,  and  every  one  has  a  direct 
interest  in  preventing  a  fire.  Lumber  in  the  United 
States  in  general  was  until  recently,  and  yet  is  in  many 
sections  of  the  country,  the  cheapest  material  for  building. 
This  economic  interest  has  expressed  itself  in  the  liberality 
of  laws  and  in  other  regulations  governing  the  construc- 
tion and  use  of  buildings.  This  country  has  been  develop- 
ing so  rapidly,  and  the  growth  of  the  cities  with  respect  to 
the  particular  location  of  classes  of  business  has  been  so 
uncertain,  that  the  buildings  have  lacked  that  permanent 
element  which  has  characterized  the  older  cities  of  Europe 
where  business  has  become  more  stabilized.  Property 
values  have  so  frequently  changed  in  our  American  cities 
without  reference  to  any  acts  of  the  owner  or  occupier  that 


PRINCIPLES  OF  INSURANCE 


flimsy  and  temporary  construction  has  often  been  the  rule 
both  as  to  business  and  residence  buildings.  The  large 
loss  on  frame  buildings  has  been  shown  in  a  previous  table, 
and  that  this  type  of  construction  is  responsible  to  a 
large  degree  for  the  heavy  loss  is  further  indicated  by 
the  following  tables. 

PER  CAPITA  FIRE  LOSS  FOR  1907  IN  ELEVEN  STATES 
WHERE  TIMBER  IS  SCARCE  AND  IN  ELEVEN  STATES 
WHERE  TIMBER  IS  PLENTIFUL 

(Statistics  gathered  by  the  United  States  Geological  Survey) 


TOTAL 
POPULATION 

TOTAL 
FIRE  Loss 

LOSS  PER 

CAPITA 

Group  i  :   States  in  which  timber  is 
scarce  : 
Iowa,    Illinois,    Oklahoma,    Con- 
necticut, Delaware,  New  Jersey, 
South    Dakota,    Rhode    Island, 
Kansas,   Nebraska,   and   North 
Dakota  

16.78'?,  4.60 

$38,606,558 

$2.30 

Group  2  :   States  in  which  timber  is 
plentiful  : 
Washington,     Louisiana,     Texas, 
Mississippi,  Wisconsin,  Arkansas, 
Michigan,  Pennsylvania,  Minne- 
sota, Oregon,  and  North  Caro- 
lina      

2?.<j6o.i;3'? 

75,801;  <Ko 

2.89 

"  The  remarkable  feature  is  the  per  capita  loss  in  the 
South-Central  States,  —  Kentucky,  Tennessee,  Alabama, 
Mississippi,  Louisiana,  Texas,  Oklahoma,  and  Arkansas, — 
namely,  $3.66,  more  than  $i  in  excess' of  the  per  capita 
loss  in  any  of  the  other  divisions.  All  of  the  states  in 
this  division  except  Oklahoma  contain  much  timber  and 


FIRE  PREVENTION  AND  THE   FIRE  LOSS     253 


therefore  many  frame  buildings.  These  states  also  have 
the  handicap  of  inefficient  fire  protection  as  compared 
with  the  states  of  the  North  and  East.  The  total  losses 
and  the  loss  per  capita  according  to  geographic  divisions 
are  shown  in  the  following  table." 

PER    CAPITA    FIRE   LOSSES    FOR    1907   IN    THE    UNITED 
STATES  BY  GEOGRAPHICAL  DIVISIONS 

(Statistics  gathered  by  the  United  States  Geological  Survey) 


GEOGRAPHIC  DIVISION 

TOTAL 
POPULA- 
TION 

TOTAL  FIRE 
Loss 

FIRE  Loss 

PER 

CAPITA 

North  Atlantic  : 

Maine,  New  Hampshire,  Vermont, 

Massachusetts,    Rhode    Island, 

Connecticut,    New    York,    New 

Jersey,  Pennsylvania     .... 

23,779,013 

$59,447,532 

$2.50 

South  Atlantic  : 

Delaware,    Maryland,    District   of 

Columbia,   Virginia,    West   Vir- 

ginia,   North    Carolina,    South 

Carolina,  Georgia,  Florida      .     . 

11,574,988 

25,349,223 

2.IQ 

North  Central  : 

Ohio,  Indiana,  Illinois,  Michigan, 

Wisconsin,     Minnesota,     Iowa, 

Missouri,  North  Dakota,  South 

Dakota,  Nebraska,  Kansas     .     . 

29,026,645 

68,793,148 

2-37 

South  Central  : 

Kentucky,    Tennessee,    Alabama, 

Mississippi,     Louisiana,     Texas, 

Oklahoma,  Arkansas     .... 

16,368,558 

59,908,922 

3-66 

Western  : 

Montana,     Wyoming,     Colorado, 

New    Mexico,    Arizona,    Utah, 

Nevada,     Idaho,     Washington, 

Oregon,  California        .... 

4,783,557 

12,676,426 

2.65 

Partly  because  of  the  extensive  use  of  lumber,  due  to 
its  cheapness,  the  people  have  been  unwilling  to  adopt 


254  PRINCIPLES  OF  INSURANCE 

strict  building  codes  and  other  legislation,  regulating 
the  use  of  buildings.  As  for  compulsory  insurance,  this 
would  outrage  the  American  people's  conception  of 
individual  liberty. 

Legal  Liability  and  the  Fire  Loss.  —  (6)  The  theory 
of  personal  liability :  Notwithstanding  that  the  principle 
of  liability  for  damages  inflicted  by  the  acts  of  one  person 
upon  another  is  a  well-recognized  one  in  the  common  law 
of  this  country,  it  has  had  little  specific  application  to  the 
case  of  fire  occurring  in  one  property  which  unnecessarily 
does  injury  to  another.  Neither  is  the  common  or  the 
statutory  law  in  the  United  States  ordinarily  applied  to 
permit  recovery  for  damages  in  such  a  circumstance. 
In  Europe  individual  responsibility  for  fire  loss  has  long 
been  a  recognized  principle  in  law.  In  America  there  is 
no  public  opinion  which  would  uphold  a  court  in  con- 
sidering one  whose  property  is  permitted  to  become  a 
fire  menace  a  public  offender  in  the  event  his  property 
burns  and  thus  causes  incidental  loss  to  his  neighbors. 
.  The  theory  of  damages  has  had  no  such  application, 
and  there  is  yet  little  indication  that  it  will  be  extended 
to  cover  such  cases.  Yet  there  are  good  grounds  for 
such  an  application.  Why  should  a  property  owner 
be  permitted  either  to  construct  or  to  use  a  building 
which  is  a  menace  to  the  property  of  his  neighbor,  who 
is  either  absolutely  helpless  to  protect  himself  or  is  com- 
pelled to  make  unnecessary  outlays  to  protect  himself 
against  the  carelessness  and  indifference  of  the  adjoining 
property  owner?  It  is  true  that  in  some  states  the  fire 
marshal  has  been  given  power  to  raze  buildings,  and 
property  owners  are  sometimes  required  to  change  the 


FIRE  PREVENTION  AND  THE  FIRE  LOSS     255 

construction  or  use  of  buildings  on  the  grounds  that  they 
become  public  nuisances  or  unduly  endanger  other 
property.  Yet  this  is  far  from  recognizing  in  law  a 
theory  of  damages  that  permits  recovery  against  an 
adjoining  property  owner  in  whose  property,  either  be- 
cause of  inferior  construction  or  improper  use,  a  fire 
occurs  which  entails  a  loss  upon  other  property  owners. 
The  complete  application  of  such  a  theory  would  permit 
recovery  against  an  occupier  or  lessee  by  the  owner  or 
lessor  insured.  Property  owners  are  expected  to  look  to 
the  insurance  company  —  which  means  other  property 
owners  —  for  recovery  of  losses.  Not  the  least  effective 
manner  of  reducing  the  large  loss  by  fire  in  the  United 
States  would  be  an  extension  of  this  principle  of  liability 
to  owners  and  occupiers  of  property.  It  would  bring  to 
the  attention  of  property  owners,  as  nothing  else  could 
do,  the  fact  that  fire  losses  are  primarily  in  the  control 
of  property  owners  and  not  in  insurance  companies  and 
fire  departments. 

Regulation  and  Fire  Loss.  —  (c)  The  regulations 
governing  insurance  as  expressed  in  laws  and  actual 
practice  are  also  responsible  in  part  for  the  large  fire 
loss.  Excessive  competition  has  been  encouraged.  This 
has  often  resulted  in  companies  accepting  risks  which 
are  likely  to  burn  and  expose  other  property.  Valued- 
policy  laws  are  in  force  in  many  states,  and  this  tends  to 
make  property  owners  less  careful  in  the  use  of  their 
property.  Anti-coinsurance  laws  are  also  in  force  in 
many  states.  The  character  of  these  laws  has  been 
previously  discussed.  Their  relation  to  the  fire  loss  as 
well  as  to  the  fire  rate  or  charge  is  important. 


256  PRINCIPLES  OF  INSURANCE 

Overinsurance.  —  (d)  Overinsurance  is  related  to 
the  preceding  causes  of  the  fire  loss.  Property  owners 
who  have  their  property  insured  to  its  full  value  or  in 
excess  of  its  value  are  likely  to  be  indifferent  in  many 
cases  about  the  occurrence  of  a  fire.  This  does  not 
often  express  itself  in  criminal  acts,  causing  fires,  but  in 
the  careless  use  of  property.  If  the  loss  was  confined  to 
the  single  property,  it  would  not  be  so  serious,  but  other 
property  is  also  exposed  to  loss.  No  one  should,  in  in- 
surance theory,  benefit  in  a  personal  manner  from  his 
insurance  policy.  But  in  actual  practice  individuals 
sometimes  do.  This,  like  all  other  unnecessary  losses 
by  fire,  expresses  itself  as  a  higher  charge  for  insurance, 
for  it  cannot  be  too  often  emphasized  that  the  public 
and  not  the  insurance  company  pays  fire  losses. 

Arson.  —  (e)  Arson  and  incendiarism  are  also  to  be 
listed  as  causes  of  the  large  fire  loss  in  the  United  States. 
A  distinction  must  first  be  made  between  arson  and  in- 
cendiarism. In  general  it  may  be  said  that  incendiarism 
is  a  term  used  to  refer  to  those  cases  where  the  owner 
deliberately  burns  his  own  property,  whereas  arson  is 
used  to  describe  those  cases  where  the  property  of  one 
is  deliberately  set  on  fire  by  another.  The  terms  in 
popular  speech  are  often  used  interchangeably.  In 
both  cases  they  are  concerned  with  the  Moral  Hazard 
of  the  risk.  These  terms  do  not  include  all  cases  of 
intentionally  produced  fires.  Fires  intentionally  pro- 
duced usually  result  from :  (a)  insanity,  drunkenness, 
mania  for  excitement;  (b)  to  conceal  crimes;  (c)  as  a 
means  of  securing  revenge;  and  (d)  for  the  purpose  of 
gain.  There  are  no  available  statistics  as  to  the  number 


FIRE  PREVENTION  AND  THE  FIRE  LOSS     257 

of  fires  which  are  due  to  the  above  causes.  After  all 
allowances  are  made  for  the  Physical  Hazard  and  care- 
lessness, there  doubtless  remains  but  a  small  percentage 
of  all  fires  which  are  due  to  incendiarism  and  arson. 
Much  is  made  in  the  press  and  public  discussion  of 
"  arson  gangs,"  with  the  result  that  an  exaggerated 
importance  is  likely  to  be  attached  to  these  causes  of 
fires.  Yet  they  are  not  unimportant.  The  National 
Board  of  Fire  Underwriters  has  since  1873  offered  re- 
wards for  the  detection,  conviction,  and  punishment  of 
incendiarism.  The  money  to  pay  such  rewards  is  con- 
tributed by  insurance  companies  which  are  members  of 
this  National  Board.  The  conditions  were  amended  in 
1913  to  include  not  only  those  acts  of  criminal  intent,  but 
also  the  acts  of  the  insane  or  feeble-minded  which  caused 
fires.  Since  1873  there  have  been  offered  6483  rewards, 
totaling  $2,148,975,  of  which  285  have  been  paid,  totaling 
$86,324.  This  was  only  4.17  per  cent  paid  of  the  amount 
offered.  There  were  during  the  period  1873  to  1915 
388  convictions.  The  explanation  of  this  large  amount 
of  unclaimed  reward  is  due  to  several  facts.  In  the  first 
place  it  is  difficult  to  secure  the  interest  of  the  owner  or 
the  public  in  an  effort  to  investigate  suspicious  fires.  The 
public  is  disposed  to  think  that  it  is  the  business  of  fire 
insurance  companies  to  pay  losses.  They  often  argue, 
"that  is  what  they  are  for,"  and  resent  too  inquisitorial 
acts  on  the  part  of  "  the  rich  insurance  companies." 
There  is  often  a  prevalent  public  hostility  to  insurance 
companies  which  public  officials,  such  as  police  officials 
and  prosecuting  attorneys,  sometimes  show. 

In  the  second  place  the  appointment  of  fire  marshals 


258  PRINCIPLES   OF   INSURANCE 

in  some  states  and  cities  has  removed  any  necessity 
of  a  reward.  These  officials  have,  as  an  important  part 
of  their  duty,  the  investigation  of  the  causes  of  fires, 
and  in  a  number  of  cases  they  have  been  responsible  for 
the  discovery  and  prosecution  of  those  guilty  of  arson 
or  incendiarism.  Public  officials  in  the  course  of  per- 
forming their  duty  are  not  eligible  as  claimants  for  any 
of  this  reward.  Statistics  from  those  states  which  in- 
vestigate the  causes  of  fires  most  carefully  show  that 
about  three  per  cent  of  the  total  number  of  fires  were 
classed,  as  to  causes,  "  incendiary  "  or  "  suspicious," 
while  about  thirteen  per  cent  was  classed  as  "  unknown." 
What  per  cent  of  these  "  unknown  causes  "  was  due  to 
arson  and  incendiarism  cannot  be  stated,  but  if  a  liberal 
estimate  is  made,  as  one  half,  this  added  to  the  known 
incendiarism  and  suspicious  percentage  would  make  a 
total  of  ten  per  cent  of  all  fires  which  are  due  to  arson  and 
incendiarism.  If  the  fire  loss  of  the  country  averages 
$225,000,000,  this  would  be  a  sum  of  twenty- two  and  one 
half  million  dollars  as  the  amount  lost  by  arson  and 
incendiarism.  This  is  probably  a  very  liberal  estimate, 
but  the  sum,  if  much  less,  is  not  an  inconsiderable  amount 
to  lose  by  such  causes.  However  meager  the  available 
statistics,  they  are  sufficient  to  disprove  both  the  popular 
notions  that  insurance  companies  are  responsible  for 
arson  and  incendiarism  and  also  that  a  large  percentage 
of  the  fires  are  due  to  these  causes. 

Specific  Causes  of  Fires.  —  An  investigation  was 
made  by  a  committee  of  the  Wisconsin  legislature  of  the 
causes  of  fires  in  forty-four  American  cities  covering 
42,311  fires.  These  cities  had  an  annual  fire  loss  of 


FIRE  PREVENTION  AND   THE  FIRE  LOSS     259 

about  $40,000,000,  and  the  statistics  given  on  the  follow- 
ing page  may  be  taken  as  representative  of  the  direct 
causes  of  fires  in  American  cities. 

It  will  be  seen  from  this  table  that  the  causes  of  28^ 
per  cent  of  the  fires  were  not  ascertainable.  In  many 
such  cases  the  fires  were  so  quickly  destructive  that  all 
evidence  of  the  causes  was  burned  up.  In  other  cases 
the  fire  started  from  causes  which  are  yet  to  be  dis- 
covered by  man.  These  unknown  fire  causes  are  the 
more  dangerous  because  of  the  mystery  which  surrounds 
them. 

The  Fire  Loss  and  the  Fire  Waste  are  evident,  but  it 
should  be  understood  that  when  it  is  stated  that  this 
loss  is  not  decreasing,  reference  is  made  to  the  aggregate 
property  loss  by  fire.  To  determine  whether  the  loss 
is  absolutely  increasing  it  should  be  correlated  with  the 
total  property  values.  That  is,  even  an  annually  in- 
creasing fire  loss  might  not  in  respect  to  total  property 
values  in  the  country  be  on  the  increase.  There  are 
no  accurate  statistics  of  the  total  building  values  of  the 
country,  and  hence  such  a  comparison  cannot  be  made. 
The  loss  can  only  be  compared  to  the  total  value  of 
insured  property,  and  as  has  been  shown,  the  burning 
ratio  shows  no  marked  decrease. 

Fire  Prevention  and  Protection.  —  In  view  of  this 
loss,  what  are  the  agencies  by  which  fires  are  sought  to 
be  prevented  and  controlled?  In  the  first  place  fire 
prevention  may  be  distinguished  from  fire  protection. 
Little  can  be  done  to  prevent  fires,  since  practically  all 
material  is  in  some  degree  combustible.  All  that  can 
be  done  is  to  reduce  the  degree  of  combustibility  by 


260 


PRINCIPLES   OF  INSURANCE 


CAUSE 


NCMBER  FIRES 


PER  CENI  FIRES 


Ashes,  hot 809 

Automobiles 205 

Boilers,  defective 46 

Candles 761 

Cigars,  cigarettes,  and  pipes   ....  1,681 

Chimneys,  sparks  from 934 

Chimneys,  defective       2,136 

Clothes  too  near  stove 62 

Electric  wiring,  defective I>°97 

Fireplaces,  defective 209 

Fireworks 313 

Flues,  defective 1,346 

Fumigating 73 

Furnaces,  defective 1,159 

Furnaces,  overheated 292 

Gas,  explosion       773 

Gasolene,  explosion .  885 

Gas  jets,  contatt  with  curtain  draperies, 

etc 492 

Gas,  leak 204 

Grease 548 

Incendiary 657 

Lapps 783 

Lightning 156 

Locomotives,  sparks  from 1,227 

Matches       2,663 

Moving  picture  machine 17 

Rubbish,  burning 4,45 2 

Smokestacks,  sparks  from 407 

Spontaneous  combustion 774 

Steam  pipes,  overheated 161 

Stoves,  defective 682 

Stoves,  gas 276 

Stoves,  gasolene 417 

Stoves,  oil 253 

Stoves,  overheated 599 

Stovepipes,  defective 1,120 

Stovepipes,  overheated 90 

Tar,  paint,  varnish,  etc 201 

Unknown 12,056 

Water  pipes,  thawing 341 

Carelessness,  general 252 

Explosives,  other  than  gas  and  gasolene  522 

Total 42,311 


1.91 

.48 

.11 

1.80 

3-97 

2.21 

5-47 
•IS 

2-59 
•49 
•74 

3-i8 
•17 

2-74 
.69 

1.83 
2.09 

1.16 

.48 
1.3° 
i-SS 
1.85 

•37 
2.90 
6.30 

.04 
io-S3 

.69 
1.83 

•38 
1.61 

•65 

•99 

.60 

1.42 

2.65 

.21 

•47 

28.50 

.81 

•59 


FIRE   PREVENTION  AND  THE  FIRE  LOSS    261 

such  means  as  using  material  which  does  not  ignite  and 
burn  easily,  and  so  constructing  the  building  and  regu- 
lating its  use  as  to  reduce  the  chances  of  fire  occurring. 
When  the  phrase  "  fire  prevention  "  is  used  in  connection 
with  public  and  private  agencies  and  devices,  relating 
to  fire,  protection  from  fire  is  usually  meant,  since  these 
agencies  are  chiefly  concerned  with  the  discovery  of 
the  fire,  the  transmission  of  the  alarm,  and  the  extin- 
guishment of  the  fire.  Before  discussing  these  agencies 
and  devices  for  fire  protection,  some  general  factors 
which  tend  to  reduce  the  fire  loss  may  be  noted. 

Factors  Reducing  the  Fire  Loss.  —  The  accurate 
measurement  of  the  fire  hazard  by  a  system  of 
schedule  rating  tends  to  reduce  this  loss,  because  it  not 
only  gives  a  credit  in  the  charge  for  every  improvement 
by  the  owner  in  the  risk,  but  it  also  induces  him  to  take 
an  interest  in  improving  the  general  protection  for  the 
community.  This  expresses  itself  as  an  interest  in 
securing  better  fire  departments  and  water  works; 
better  building  codes,  better  streets,  more  careful  use 
of  his  neighbor's  as  well  as  his  own  property,  and  in  many 
other  ways.  That  is,  schedule  rating  brings  fire  protec- 
tion and  prevention  to  the  citizen  as  a  dollar  and  cents 
proposition.  Probably  no  other  one  thing  has  done 
more  to  reduce  the  fire  loss  than  devising  a  fire  rate 
which  measures  the  hazard  by  this  system  of  debits 
and  credits. 

Fireproof  Buildings.  —  Construction  as  it  expresses 
itself  in  fireproof  buildings  has  been  suggested  as  a 
factor  affecting  favorably  the  fire  loss.  But  however 
fireproof  the  material  may  be,  its  arrangement  in  the 


262  PRINCIPLES  OF  INSURANCE 

building,  as  well  as  the  contents  of  the  building  and  its 
use,  often  make  the  term  "  fireproof  "  of  little  signifi- 
cance so  far  as  the  loss  by  fire  is  concerned.  More 
than  one  "  fireproof  "  building  has  been  destroyed  by 
fire  and  many  more  have  had  their  contents  burned. 
The  warning  need  scarcely  be  given  that  many  buildings 
advertised  or  stated  to  be  fireproof  are  far  from  it. 
Constructing  and  advertising  fireproof  buildings  has 
become  so  popular  since  some  of  the  recent  conflagrations 
in  the  United  States,  that  this  popularity  itself  should 
arouse  a  suspicion  as  to  the  real  character  of  many  of 
these  buildings,  reported  as  fireproof.  None  of  the 
most  extensively  used  building  materials  in  cities  has  a 
high  degree  of  combustibility.  It  is  in  the  arrangement 
of  the  building  with  respect  to  hallways,  stairways, 
openings  between  floors,  communications  on  the  same 
floor,  and  in  other  respects,  such  as  the  character  of  the 
occupancy,  that  the  absence  of  the  "  fireproof  "  char- 
acter is  to  be  found.  The  certainty  with  which  a  fire 
is  prevented  from  spreading  in  the  building  or  to  the 
building  from  an  outside  source  gives  it  the  true  char- 
acter of  a  fireproof  building. 

Educational  Agencies.  —  Another  general  factor  which 
has  tended  to  reduce  the  fire  loss  is  the  educational  work 
which  has  been  done.  This  takes  the  form  of  publicity 
work  of  many  kinds.  Fire  Prevention  Societies  are  or- 
ganized to  direct  the  public's  attention  to  the  enormous 
loss  by  fire  and  to  acquaint  them  with  methods  of  re- 
ducing it.  Fire-prevention  days  and  "  clean-up  days  " 
are  proclaimed  by  governors  of  states  and  mayors  of 
cities.  Public  lectures  on  the  subject  are  given.  Schools 


FIRE   PREVENTION  AND   THE   FIRE  LOSS     263 

and  colleges  direct  attention  to  the  subject.  The  public 
press  prints  articles  or  publishes  advertisements  on  the 
subject.  Manufacturers  of  fire  extinguishers,  automatic 
sprinklers,  and  other  devices,  through  advertisements 
of  their  article,  have  a  part  in  this  educational  work  in 
reducing  the  fire  loss. 

Private  Agencies  Reducing  Fire  Loss.  —  It  has  been 
stated  that  fire  protection  concerns  itself  with  the  dis- 
covery of  the  fire,  the  transmission  of  the  alarm,  and  the 
extinguishment  of  the  fire.  The  agencies  and  methods 
for  fire  protection  may  be  discussed  under  the  two  classes 
of  Private  and  Public  Agencies.  Among  the  most  im- 
portant private  agencies  for  fire  protection  are  the  direct 
and  indirect  activities  of  the  fire  insurance  companies. 
The  effect  of  their  system  of  determining  rates  has  al- 
ready been  discussed.  The  National  Board  of  Fire 
Underwriters,  which  is  composed  chiefly  of  the  stock 
fire  insurance  companies,  has  established  underwriters' 
laboratories  which  examine  and  test  materials  and 
devices  for  fire  protection.  Manufacturers  submit 
their  material  to  these  laboratories  for  tests,  which  are 
made  at  cost.  If  they  are  satisfactory,  approval  is 
given  and  each  article,  such  as  a  fire  door,  a  conduit,  a 
hose,  an  incubator,  or  fire  extinguisher,  has  attached  to 
it  the  laboratory's  label  of  inspection.  The  results  of 
the  examinations  are  published  or  made  available  on 
printed  cards  at  the  inspection  bureaus  throughout  the 
country,  insurance  offices,  federal,  state,  and  municipal 
offices.  Much  information  is  also  distributed  free  to 
the  public.  The  purpose  of  all  this  work  is  stated  in  the 
1915  report  of  the  Underwriters  Laboratories  to  be  "  to 


264  PRINCIPLES  OF  INSURANCE 

secure  the  best  and  fairest  opinion  regarding  the  merits 
or  demerits  of  every  device,  system,  machine,  or  material, 
in  respect  to  life  and  fire  hazards,  and  accident  preven- 
tion, and  to  have  the  work  so  conducted  and  reviewed 
as  to  secure  accuracy  and  uniformity  in  its  findings." 
This  object  has  been  accomplished  to  such  an  extent  that 
the  majority  of  underwriters  in  the  United  States,  many 
state  and  municipal  authorities,  plant  operators,  and  a 
large  number  of  architects,  building  owners  and  users, 
either  accept  or  require  a  report  from  these  laboratories 
incident  to  their  recognition  of  devices,  systems,  and 
materials  having  a  bearing  upon  fire  hazards  or  accident 
prevention.  Underwriters'  Laboratories  issue  no  guar- 
antee that  their  findings  will  be  accepted  or  recognized 
in  any  case.  Such  assurances  can  only  be  obtained  from 
the  authority  having  jurisdiction. 

By  the  work  of  this  organization  and  other  activities 
of  the  parent  organization  —  the  National  Board  of 
Fire  Underwriters  —  there  has  been  a  formulation  of 
many  rules  for  the  installation  and  use  of  materials  as 
well  as  the  adoption  of  many  standards  for  material 
and  appliances.  These  organizations  have  cooperated 
in  this  work  with  insurance  companies,  the  agents,  in- 
spectors, and  inspection  bureaus. 

Effect  of  Inspection.  —  The  inspection  of  property  by 
insurance  companies  or  by  private  agencies  which  do 
this  work  for  the  insurance  companies  has  done  much  to 
prevent  fires.  The  beginning  of  this  work  was  when 
the  risk  was  inspected  at  the  time  of  writing  the  policy. 
Later  the  risks  were  inspected  to  secure  cleanliness,  but 
it  has  now  developed  into  a  system  of  regular  periodic 


FIRE  PREVENTION  AND   THE  FIRE  LOSS     265 

inspection  of  everything  connected  with  construction, 
equipment,  occupancy,  and  processes.  In  fact  a  phase 
of  this  work  begins  before  the  building  is  constructed. 
The  plans  of  the  proposed  building  are  often  submitted 
to  the  insurance  company  or  its  representatives  with 
the  view  of  preventing  fire  and  securing  a  low  rate  on 
the  insurance.  The  contracts  for  construction  work, 
especially  with  that  part  having  to  do  with  electrical 
installation,  power  equipment,  and  other  hazardous 
features  of  the  building,  are  inspected.  Various  phases 
of  the  construction  work  during  the  process  of  building 
are  inspected,  and  finally  upon  completion  of  the  build- 
ing, a  general  inspection  is  made.  At  regular  intervals 
an  inspection  is  made  of  the  building  as  to  the  use  of  it 
and  the  condition  of  the  material  and  equipment  under 
use.  Municipal  Fire  Prevention  Bureaus  and  local  inspec- 
tion bureaus  do  much  of  this  work  of  inspection.  All 
this  activity  operates  powerfully  to  reduce  the  loss  by  fire. 
Automatic  Sprinklers.  —  One  of  the  most  important 
private  agencies  which  gives  fire  protection  is  the  Auto- 
matic Sprinkler  System.  It  consists  of  peculiarly  con- 
structed water  valves,  a  series  of  pipes  throughout  the 
building,  and  a  source  of  supply  of  water.  The  valve  is 
held  shut  by  a  solder  which  melts  at  a  certain  tempera- 
ture. As  this  solder  melts  the  valve  opens  and  the  water 
rushes  up  through  the  valve  from  the  piping,  into  which 
the  valve  is  screwed,  against  a  distributing  plate  or 
deflector  on  the  top  of  the  valve.  This  causes  the 
water  to  be  sprayed  out  on  the  fire  below.  These 
sprinkler  heads  or  valves  are  located  at  intervals  of  about 
ten  feet  each  way  on  a  smooth  ceiling.  They  are  always 


266  PRINCIPLES  OF  INSURANCE 

located  with  the  head  pointing  towards  the  ceiling  except 
where  a  pendant  position  is  absolutely  necessary.  The 
distance  from  the  ceiling  of  the  sprinkler  head  is  from 
four  to  six  inches.  The  fusible  metal,  which  holds  the 
valve  closed,  can  be  made  to  melt  at  any  desired  tem- 
perature. In  the  ordinary  buildings  of  a  mercantile 
character  the  metal  melts  at  160°  F.  The  heat  comes 
from  the  incipient  fire  below.  The  exact  time  elapsing 
from  the  beginning  of  the  fire  until  the  sprinkler 
head  begins  to  discharge  water  varies  with  the  height 
of  the  ceiling,  the  condition  of  the  air  in  the  room,  the 
character  of  the  fire,  that  is,  whether  it  smolders  or  burns 
rapidly,  as  well  as  other  circumstances  and  conditions. 
Ordinarily  the  time  elapsing  averages  about  a  minute. 

The  amount  of  water  discharged  by  a  sprinkler  varies 
with  the  pressure,  but  in  an  ordinary-sized  head  and  pipe, 
fifteen  gallons  are  discharged  at  a  pressure  of  five  pounds, 
nineteen  gallons  at  ten  pounds,  thirty-one  gallons  at 
twenty-five  pounds,  and  forty  gallons  at  fifty  pounds 
pressure.  Each  sprinkler  covers  and  protects  an  area 
of  about  ten  feet  square,  and  even  under  a  low  pressure 
this  discharges  an  amount  of  water  far  in  excess  of  that 
falling  during  the  most  violent  rainstorm.  The  rapidity 
with  which  the  water  is  discharged  and  the  amount 
discharged  are  therefore  responsible  for  the  marvelous 
success  of  automatic  sprinklers  as  a  fire  protective 
device.  There  must  be  a  sufficient  number  of  these 
valves  or  sprinkler  heads,  and  merchandise  or  material 
must  not  be  piled  up  to  the  ceiling  to  interfere  with 
their  operation.  The  pipes  into  which  these  heads  are 
screwed  are  run  throughout  the  building  into  every 


FIRE   PREVENTION  AND  THE  FIRE  LOSS     267 

corner,  into  stairways,  and  between  joists,  so  that  water 
can  be  sprinkled  on  every  space  when  fire  breaks  out. 
The  success  of  a  sprinkler  system  is  wholly  dependent 
upon  getting  water  on  a  fire  before  it  gets  under  head- 
way. The  size  of  these  pipes  differs,  depending  upon 
the  number  of  heads  which  they  are  to  carry  and  the 
amount  of  space  they  are  to  protect.  They  decrease  in 
size  as  they  are  distant  from  the  main  supply  pipes. 
The  smallest  pipe  is  f  inch  and  carries  one  head,  whereas 
the  three-inch  pipe  carries  thirty-six  heads.  The  piping 
must  be  securely  fastened  to  the  ceiling,  for  the  value  of 
the  system  depends  upon  the  valves  opening  promptly. 
The  pipes  are  slanted  or  pitched  to  drain  them,  the 
usual  pitch  being  %  inch  to  ten  feet. 

This  series  of  pipes  running  throughout  a  building  is 
supplied  with  water  from  the  main  standpipes  or  "  risers." 
Since  the  success  of  the  system  depends  upon  an  adequate 
and  certain  supply  of  water,  two  sources  of  water  supply 
to  the  main  supply  pipes  are  usually  provided.  One 
source  is  from  a  tank  located  on  the  roof  of  the  building, 
or  in  the  loft.  The  other  source  is  from  the  city  water 
mains,  to  which  connection  is  made  by  the  "  Siamese  " 
connections,  whereby  water  is  pumped  into  the  system. 
In  some  cases  two  tanks  are  used,  one  of  which  is  a  pres- 
sure tank,  that  is,  a  metal,  boiler-like  tank,  partially  filled 
with  water  under  compressed  air.  In  other  cases  special 
water  pumps  are  used.  In  all  cases  the  particular  object 
is  to  get  an  adequate  supply  of  water  to  the  fire  as 
quickly  as  possible. 

The  Wet,  Dry,  and  Open  Systems.  —  There  are 
different  kinds  of  sprinkler  systems  such  as  the  "  wet," 


268  PRINCIPLES  OF  INSURANCE 

"  dry,"  and  "  open  "  systems.  The  wet  system  is  one 
which  contains  pipes  full  of  water  at  all  times.  The  dry 
system,  which  is  used  when  there  is  a  danger  of  the  water 
freezing,  is  one  in  which  the  pipes  are  normally  empty. 
When  a  fire  occurs,  the  fusible  metal  in  the  valve  melts, 
the  air  escapes,  releasing  the  pressure  of  the  air  which 
kept  the  water  back  to  a  definite  point  in  the  supply  pipe 
where  there  was  no  danger  of  freezing.  The  water  then 
rushes  to  the  sprinkler  head  and  discharges  through  it 
on  the  fire. 

The  open  system  is  used  to  protect  buildings  against 
fires  in  adjacent  properties.  In  this  system  the  valves 
are  open  and  the  pipes  are  empty.  Water  is  turned  into 
the  pipes  and  flows  out  through  the  open  valves  over  the 
windows  and  walls  or  cornices  and  roofs  to  be  protected. 

Any  system  of  automatic  sprinklers  must  be  carefully 
inspected  from  time  to  time  to  see  that  it  is  in  condition 
to  do  promptly  the  work  for  which  it  was  installed. 
Various  signaling  devices  have  been  invented  by  which 
an  alarm  is  given  when  a  sprinkler  head  opens.  This 
is  necessary  in  order  that  aid  may  be  given  in  case  of  a 
fire  and  also  to  protect  the  contents  when  a  head  may 
accidentally  open,  as,  for  example,  from  excessive  heat, 
defective  condition,  freezing,  or  from  any  other  cause. 
The  chief  alarm  valves  used  are  the  electric  and  the 
mechanical  alarm,  which  is  automatically  given  to  any 
desired  point,  such  as  the  general  office,  the  boiler  room, 
or  to  a  telegraph  office. 

Efficiency  of  Sprinklers.  —  The  efficacy  of  the  Auto- 
matic Sprinkler  System  is  beyond  question.  The 
records  of  the  National  Fire  Protection  Association 


FIRE  PREVENTION  AND  THE  FIRE  LOSS     269 

cover  14,353  fires  in  sprinklered  risks,  of  which  30 
per  cent  were  put  out  by  one  sprinkler,  46.6  per  cent  by 
not  more  than  two  sprinklers,  73  per  cent  by  not  more 
than  six  sprinklers,  and  84.8  per  cent  by  not  more  than 
twelve  sprinklers.  Less  than  5  per  cent  of  these 
sprinklered  risk  fires  were  not  satisfactorily  controlled, 
and  this  fact  was  due  to  the  water  being  shut  off,  obsolete 
or  corroded  sprinklers,  poor  water  supply,  conflagration 
exposure,  obstruction  in  the  system,  or  inadequate  num- 
ber of  sprinklers.  New  York  in  1912  required  the  instal- 
lation of  an  automatic  sprinkler  system  in  every  factory 
building  of  over  seven  stories  or  ninety  feet  in  height, 
in  which  wooden  flooring  is  used  and  where  more  than 
two  hundred  people  are  regularly  employed  above  the 
seventh  floor  or  more  than  ninety  feet  above  the  ground. 
Their  efficiency  is  recognized  by  insurance  companies  in 
making  the  insurance  rate  on  the  risk.  An  allowance 
from  i  o  to  90  per  cent  is  made  in  the  rate  for  a  sprinkler 
equipment.  These  automatic  sprinkler  systems  are 
efficient  chiefly  because  they  do  not  depend  upon  the 
human  agency  for  their  operation.  They  prevent  a 
fire  from  getting  under  way.  Manifestly  they  must 
depend  on  the  human  agency  for  proper  installation  and 
inspection  to  warrant  that  they  will  operate.  They  are 
installed  by  private  companies. 

In  addition  to  the  private  agencies  already  enumerated 
which  protect  against  fire,  such  others  as  those  which 
manufacture  fire  extinguishers,  fireproof  paints,  hose, 
and  other  devices  may  be  mentioned.  There  is  also 
the  Watchman  Service  and  Alarm  Service.  The  Alarm 
Service  is  in  general  either:  (a)  Watchman,  (b) 


270  PRINCIPLES  OF  INSURANCE 

Automatic  Alarms,  or  (c)  Sprinkler  Alarm  Service. 
The  Watchman  Service  with  the  different  methods  of 
reporting  is  well  known.  The  Automatic  Alarm  Sys- 
tems are  chiefly  dependent  upon  the  thermostat;  that 
is,  a  device  which  when  sufficiently  heated  gives  an  alarm. 
When  the  temperature  of  a  room  is  raised  by  heat  beyond 
a  certain  point,  an  electric  circuit  is  completed  by  the 
action  of  the  thermostat.  There  are  many  different 
types  of  thermostats,  some  depending  for  their  opera- 
tion upon  the  expansion  of  metals  or  of  volatile  liquids, 
and  others  upon  the  releasing  of  air  pressure,  and  others 
upon  the  making  or  breaking  of  an  electric  circuit  by 
the  melting  of  solder.  They  all  rely  upon  their  efficacy 
in  transmitting  a  signal  to  a  point  where  a  fire  has 
broken  out  in  the  building,  and  not  as  the  sprinkler 
system,  in  putting  out  the  fire.  There  are  other  minor 
private  agencies  which  act  as  a  protection  against  fire, 
but  these  are  too  well  known  to  need  discussion. 

Public  Agencies  Reducing  the  Fire  Loss.  —  There 
remain  for  consideration  the  public  agencies  for  fire 
protection,  and  among  others  the  following  important 
ones  may  be  discussed. 

(a)  Building  Codes. 

These  codes  regulate  the  construction,  equipment, 
and  use  of  buildings.  It  is,  for  reasons  previously  dis- 
cussed, often  difficult  to  secure  the  enactment  of  a  good 
building  code,  but  its  effect  on  fire  protection  cannot  be 
doubted.  A  great  variety  of  subjects  are  included  in 
building  codes ;  such,  for  example,  as  the  kind  of  material 
to  be  used  in  certain  districts  of  a  city,  the  thickness 
of  the  walls,  the  roofing  material,  elevators,  construe- 


FIRE  PREVENTION  AND   THE   FIRE  LOSS     271 

tion,  wiring  and  heating  installations,  fire  escapes,  the 
storing  and  use  of  materials  in  the  buildings.  The 
purpose  of  such  codes  is  not  only  to  protect  property, 
but  also  persons  who  are  employed  in  the  buildings. 
Under  the  regulations  of  good  building  codes,  the  "  fire- 
proof "  building  is  substantially  fireproof  in  respect  to 
any  serious  injury  to  the  building,  but  too  often  the 
contents  may  be  unnecessarily  injured  as  well  as  con- 
siderable loss  of  life  may  occur  in  the  event  of  a  fire. 
The  communications  between  floors,  that  is,  doors, 
elevators,  and  partitions  and  divisions  of  a  single  floor, 
are  often  of  a  character  which  does  not  resist  the  spread 
of  a  fire.  If  elevator  shafts  are  inclosed,  if  fire  doors 
are  used,  metal  window  frames  with  wired  glass,  fire 
escapes,  and  a  sprinkler  system,  there  is  in  a  fireproof 
building  little  chance  that  large  injury  will  be  done 
either  to  property  or  persons  in  case  of  a  fire.  No 
building  is  more  fireproof  than  its  doors  and  windows. 
To  confine  a  fire  to  its  point  of  origin  is  to  control  it. 

The  Height  of  Buildings.  —  There  is  some  sentiment 
developing  in  this  country  to  regulate  the  height  of 
buildings,  both  because  of  the  increasing  fire  hazard  and 
also  because  of  its  relation  to  the  subject  of  light  in  build- 
ings, the  congestion  of  people  in  the  streets  and  on  trans- 
portation lines,  and  other  attendant  evils.  In  European 
cities  this  matter  has  long  been  a  subject  of  regulation. 
In  the  United  States  the  streets  were  laid  out  before  the 
era  of  skyscrapers,  with  the  result  that  in  many  American 
cities  the  streets  are  much  too  narrow  both  to  accommo- 
date the  street  crowds  and  to  permit  a  proper  distribution 
of  light.  Examples  of  property  values  being  greatly  re- 


272 

duced  by  the  erection  of  skyscrapers  are  not  uncommon. 
The  uneven  building  line  is  characteristic  of  American 
cities  in  the  business  districts,  even  in  those  of  small 
population.  The  difficulty  of  escape  from  these  high 
buildings  by  their  occupants,  in  case  of  fire,  has  been  illus- 
trated many  times.  To  secure  the  best  results  from 
the  play  of  a  hose  stream  of  water  on  a  fire,  it  is  necessary 
to  have  the  stream  of  water  at  as  nearly  a  horizontal 
position  as  is  possible.  Beyond  a  height  of  eighty-five 
to  one  hundred  feet  it  is  necessary  to  enter  the  building 
and  lay  the  hose  or  to  depend  upon  elevators  and  stand- 
pipes  which  are  likely  to  be  unavailable.  The  fire 
apparatus  will  not  usually  deliver  an  effective  stream  of 
water  to  a  greater  height  than  one  hundred  feet.  It  is 
usually  the  practice,  when  the  height  of  buildings  is 
limited,  to  base  it  upon  the  width  of  the  street,  the  ratio 
of  building  height  being  from  one  and  one  half  to  two 
and  one  half  times  the  width  of  the  street  with  a  maxi- 
mum height  for  the  building.  Certain  exceptions  are 
permitted  in  such  provisions  of  building  codes. 

The  importance  of  fire  escapes  in  protecting  life  in 
case  of  fire  is  too  evident  to  need  discussion.  There 
has  been  in  the  United  States  a  strange  resistance  to 
providing  them,  and  not  infrequently  are  they  improperly 
placed,  inadequately  supplied,  and  of  a  "  makeshift" 
character. 

Fire  Marshals.  —  The  work  of  fire  marshals  has 
had  a  very  large  effect  in  the  prevention  of  fires  and  in 
reducing  the  loss  of  property  and  life.  These  marshals 
are,  however,  not  found  in  a  majority  of  the  states.  In 
some  cases,  cities  have  provided  either  for  an  official  of 


FIRE   PREVENTION  AND  THE  FIRE  LOSS     273 

this  character  or  have  delegated  similar  work  to  regular 
officials  or  departments.  When  a  specific  law  provides 
for  the  appointment  of  such  an  official  by  the  state, 
special  powers  are  granted.  Deputy  fire  marshals  are 
appointed  to  have  supervision  over  specified  districts 
of  the  state.  The  work  of  the  fire  marshal's  office  is 
of  many  kinds.  The  causes  of  fires  are  investigated, 
statistics  of  fires  are  collected,  and  a  large  amount  of 
investigative  work  is  done  in  connection  with  the  con- 
dition of  buildings,  their  use,  and  the  installation  of 
fire  escapes.  Buildings  are  condemned  or  are  required 
to  be  demolished  or  their  further  use  is  prohibited.  In 
addition  a  large  amount  of  educational  work  is  done 
through  the  public  press,  in  public  addresses,  and  in 
publishing  annual  reports.  In  some  states  textbooks 
or  lessons  on  fire  prevention  are  prepared  for  use  in  the 
public  schools. 

Fire  Departments  and  Waterworks.  —  The  relation 
of  Fire  Departments  and  Waterworks  as  a  public  agency 
for  fire  protection  is  very  important.  In  practically  all 
the  important  cities  in  the  United  States  the  fire  de- 
partment has  become  a  public  agency.  In  the  earlier 
days  the  voluntary  fire  department  was  common,  and  in 
addition  fire  salvage  corps  were  much  relied  upon  to 
protect  property  at  the  time  of  the  fire.  The  fire  depart- 
ments are,  as  a  rule,  in  the  United  States  efficient,  espe- 
cially in  all  the  larger  cities.  The  degree  of  efficiency 
depends  upon  several  factors,  such  as : 

(a)  the  personnel  of  the  force.  This  depends  upon 
the  carefulness  with  which  the  members  are  selected, 
the  ability  of  the  head  of  the  department,  the  free- 


274  PRINCIPLES  OF  INSURANCE 

dom  from  political  influence,  and  the  certainty  of  tenure 
of  position. 

(b)  The  equipment  of  the  department.     This  takes 
the  form  of  adequacy  in  respect  to  number  of  men  and 
apparatus ;  that  is,  the  engines,  hose,  and  other  fire- 
fighting  equipment. 

(c)  The  most  approved  fire  alarm  system,  in  order  that 
the  department  may  quickly  reach  the  fire,  for  the  most 
important  factor  in  reducing  the  fire  loss  is  the  control  of 
the  fire  in  its  early  stages.     An  incipient  fire  becomes  in 
any  American  city  a  large  fire  and  a  conflagration  because 
it  is  not  controlled  in  its  early  stages.     Economy  in  the 
government  of  American  cities  can  least  of  all  be  afforded 
in  connection  with  the  Fire  and  Water  Departments,  for 
a  devastating  fire  is  a  possibility  in  any  city  of  this 
country. 

The  importance  of  the  Waterworks  Department  as 
a  public  agency  for  fire  protection  consists  chiefly  in  the 
adequacy  of  pressure  and  of  water  mains.  Pipes  of 
proper  size  in  the  business  and  residence  districts  with 
adequate  pressure  are  absolutely  necessary  for  the 
control  of  fires,  either  by  private  agencies  such  as  sprinkler 
systems  or  by  the  public  agency  of  a  fire  department. 
In  a  number  of  cities  high  pressure  water  mains  are 
provided  in  the  congested  districts.  Fire  boats  with 
powerful  pumps  are  used  in  cities  along  the  coast  or 
large  inland  bodies  of  water  to  protect  the  property 
along  the  water  front. 

In  addition  to  the  preceding  public  agencies  enu- 
merated and  other  minor  ones,  there  are  also  laws, 
regulating  the  shipping  and  storing  of  explosives  and 


FIRE  PREVENTION  AND  THE  FIRE  LOSS     275 

highly  inflammable  materials.  A  federal  law  regulates 
the  manner  of  shipping  dynamite.  Local  laws  regulate 
its  storing.  Laws  regulate  the  shipping,  storage,  and 
use  of  such  materials  as  nitroglycerine  and  gasolene. 

In  addition  to  the  work  of  the  private  agencies  in 
testing  materials,  various  public  departments  of  the 
federal,  state,  and  local  governments  do  a  large  amount 
of  testing  and  inspecting  materials  as  to  their  fire-resist- 
ing character.  No  nation  spends  as  much  per  capita 
in  the  work  of  fire  prevention  and  fire  protection  as  the 
people  of  the  United  States  in  the  form  of  an  outlay  after 
property  is  created.  Yet  the  fire  loss  continues.  It 
undoubtedly  would  be  much  greater  were  it  not  for  this 
large  expenditure.  The  hope  for  its  permanent  reduc- 
tion is  not  primarily  in  increasing  expenditures  for  the 
previously  described  agencies  for  fire  protection,  but  in 
a  clearer  recognition  of  the  false  economy  involved. 
That  is,  a  permanent  reduction  will  be  made  only  when 
the  people  are  willing  to  submit  to  more  stringent  re- 
quirements governing  the  building  and  use  of  property. 
The  true  source  of  reduction  is  not  in  fire  protection  as 
that  term  is  now  understood  in  the  United  States,  but 
in  fire  prevention;  that  is,  not  in  reducing  the  loss  of 
property  and  lives  after  a  fire  occurs,  but  in  preventing 
the  fire  from  occurring. 

REFERENCES 

Proceedings  of  the  National  Board  of  Fire  Underwriters  (Annual 

Reports). 
The  Fire  Tax  and  Waste  of  Structural  Material  in  the  United 

States.    The  United  States  Geological  Survey,  Bulletin  418. 


276  PRINCIPLES  OF  INSURANCE 

Lectures  on  Fire  Insurance  —  The  Insurance  Library  of  Boston. 

The  Insurance  Year  Book  (1915). 

Fire  Facts  for  Business  Men.    The  General  Fire  Extinguisher 

Company,  Providence,  R.I. 
The  Business  of  Insurance,  Vol.  I,  Chaps.  XII  and  XIII. 


CHAPTER  XII 

RELATION   OF   THE   STATE   TO   INSURANCE 

The  Bases  of  State  Regulation  of  Insurance.  —  We 
have  seen  from  the  previous  description  of  the  char- 
acter of  insurance  and  the  methods  of  its  sale  that  it  is 
a  business  which  must  concern  itself  with  large  num- 
bers of  individuals.  It  demands  an  agreement  between 
sellers  and  buyers  of  a  valuable  thing  —  indemnity  — 
in  which  the  terms  of  the  sale  are  frequently  misunder- 
stood. It  demands  the  association  of  individuals  in 
order  to  secure  a  thing  which  no  one  could  secure  for 
himself.  It  is  a  cooperation  among  many  in  which  a 
general  interest  is  present,  but  in  which  also  an  individ- 
ual or  a  group  of  individuals  may  seek  to  benefit  at  the 
expense  of  the  many.  The  contracts  which  are  made, 
particularly  in  life  insurance,  continue  for  long  periods 
of  time  and  the  settlements  for  which  they  provide 
cannot  be  enforced  in  most  cases  by  the  original  party 
to  the  contract,  but  must  rest  either  upon  the  good  faith 
of  the  other  party  or  upon  the  compulsion  of  a  third 
party  —  the  state. 

Since  the  obligations  of  an  insurance  company  are 
chiefly  in  the  future,  errors  due  to  ignorance  or  dis- 
honesty do  not  immediately  disclose  themselves.  The 
policyholder  cannot  usually  withdraw  without  loss  to 
himself.  The  business  of  insurance,  both  on  account 

277 


278  I  PRINCIPLES  OF  INSURANCE 

of  the  difficulty  in  comprehending  the  principles  under- 
lying it  and  also  on  account  of  the  complexity  of  its 
actual  transaction,  is  such  that  the  average  policy  holder 
cannot  determine  for  himself  the  soundness  of  the  com- 
pany. Even  if  he  should  discover  evils  in  its  operation, 
he  usually  neither  knows  how  to  correct  them  nor 
how  to  protect  himself.  The  business  of  insurance  is 
almost  wholly  conducted  with  the  funds  of  the  policy- 
holder,  who  receives  for  his  payments  a  simple  promise 
to  pay  a  sum  at  some  future  time. 

There  would  therefore  seem  to  be  good  reasons  for  the 
activity  of  the  state  in  order  that  the  principles  of  just- 
ness and  equity  may  be  preserved.  The  state  should 
not  only  protect  the  weak  against  the  unjust  activity  of 
the  strong,  but  it  should  also  prohibit  large  numbers 
of  its  citizens  from  doing  an  injury  to  themselves.  In 
this  last  mentioned  capacity,  it  should,  for  example, 
prohibit  a  group  of  individuals  from  organizing  them- 
selves into  an  assessment  company  to  do  a  thing  which 
past  experience  has  shown  to  be  impossible.  The  state 
is  particularly  interested  in  compelling  contracts  to  be 
carried  out,  and  since  the  insurance  contract  involves 
rights  and  benefits  extending  beyond  the  lifetime  of 
one  party  to  the  contract,  it  finds  an  important  sphere 
of  action  in  the  insurance  business.  It  is  also  inevitable 
when  a  business  has  to  do  with  so  many  persons,  as  does 
insurance,  that  some  of  these  persons  will  at  times  at- 
tempt to  practice  fraud  on  the  group,  and  this  prac- 
tice the  state  must  seek  to  prohibit.  Although  insurance 
is  a  business  in  which  many  are  necessarily  interested, 
its  very  character  precludes  the  many  from  having 


RELATION  OF  THE  STATE  TO  INSURANCE     279 

any  direct  part  in  the  actual  conduct  of  the  business, 
and  it  is  therefore  incumbent  upon  the  state  to  do  what 
it  can  to  protect  the  many  against  the  possible  careless- 
ness, ignorance,  or  dishonesty  of  some  officials  of  some 
companies. 

It  is  coming  to  be  more  clearly  recognized  that  the 
state  amidst  the  present-day  complexity  of  commercial 
activities  and  the  intricacies  of  modern  business  organ- 
ization cannot  depend  upon  publicity  and  competition 
to  secure  protection  to  its  citizens.  If  publicity  simply 
means  informing  the  public  what  an  organization  is 
doing,  the  state  defaults  its  duty  to  its  citizens  by  this 
negative  approval  of  the  thing  done  and  leaves  in  many 
cases  but  an  incomplete  means  of  redress,  and  in  other 
cases  none. 

Popular  Fallacies  Regarding  Insurance.  —  Much  of 
the  confusion  in  thought  and  opinion,  as  to  what  the 
relation  of  the  government  to  the  business  of  insurance 
should  be,  arises  very  largely  from  a  general  ignorance  or 
a  mistaken  understanding  of  what  insurance  is.  The 
popular  notions  and  sophisms  of  insurance  are  to  be 
found  in  the  case  of  scarcely  any  other  business. 

The  first  fallacy  is,  that  insurance  is  a  completely 
competitive  business  and  therefore  the  public  can  bene- 
fit in  the  price  by  encouraging  and  compelling  independ- 
ent action  on  the  part  of  all  companies  in  selling  their 
commodity.  This  fallacy  will  be  treated  more  fully  in 
a  later  part  of  the  discussion,  but  at  this  point  attention 
may  be  called  to  the  fact  that  both  in  life  and  fire  in- 
surance a  large  part  of  the  work  of  the  company  is  to 
distribute  a  cost  already  entailed  on  the  public  by  the 


28o  PRINCIPLES  OF  INSURANCE 

mortality  and  burning  rates.  It  is  true  that  in  all 
businesses  there  are  overhead  costs,  and  therefore  there 
is  a  field  for  the  play  of  competitive  forces  among  the 
producers  of  the  service;  but  a  large  part  of  the  total 
cost  in  insurance  is  fixed  by  forces  over  which  the  pro- 
ducer has  no  control.  In  distributing  this  cost  there 
may  occur  unjust  apportionments  of  it  and  the  over- 
head costs  may  be  too  large.  Nevertheless,  no  amount 
of  competition  can  directly  affect  for  any  one  company 
the  fixed  charges  which  rest  as  a  whole  upon  all  com- 
panies. 

The  second  fallacy  is  a  popular  notion  that  insurance 
is  a  business,  suited  for  profit-taking,  that  is,  profit  in 
the  technical  economic  sense.  It  is  true  that  both  life 
and  fire  insurance  as  conducted  have  often  been  and 
still  are  in  some  cases  of  this  character.  It  is  also  true 
that  denying  to  it  these  characteristics  might  seem  to 
lead,  as  a  logical  conclusion,  to  a  state  monopoly  of  in- 
surance. This  is  not,  however,  a  necessary  conclusion. 
Nor  do  life  and  fire  insurance  stand  on  a  par  as  regards 
this  profit-taking  characteristic,  for  the  reason  that  fire 
insurance  has  within  it  elements  of  risk,  and  also  has 
demands  for  the  enterpriser's  ability  which  warrant  under 
our  present  economic  system,  profit  taking.  It  is  be- 
lieved, however,  that  the  essential  and  fundamental 
characteristics  of  life  insurance  are  such  that  only  pure 
wages,  rent,  and  interest  are  justified. 

The  third  fallacy  —  In  the  third  place  it  is  generally 
believed  that  insurance  is  a  peculiarly  profitable  busi- 
ness for  those  engaged  in  it;  that  is  to  say,  that  the 
stockholders  or  owners  of  the  companies  receive  un- 


RELATION  OF  THE   STATE  TO  INSURANCE     281 

usually  high  interest  on  the  capital  invested.  This  is 
supposed  to  be  especially  true  in  the  case  of  fire  insur- 
ance companies.  Apparent  proof  of  this  fact  is  given 
by  the  quotations  of  the  market  value  of  fire  insurance 
stock,  some  of  which  is  many  fold  above  par,  and  fur- 
ther by  the  large  dividends  of  20  to  30  per  cent  which 
some  companies  declare.  These  facts  do  not  them- 
selves warrant  the  conclusion  that  fire  insurance  stands 
out  among  other  businesses  as  peculiarly  profitable. 
The  mere  fact  that  no  particular  obstacles  are  in  the 
way  of  any  group  of  individuals  organizing  a  life  or  fire 
insurance  company,  and  the  additional  fact  that  there 
is  always  free  capital  seeking  the  highest  possible  re- 
turn, irrespective  of  the  nature  of  the  investment,  ought 
to  be  sufficient  to  prove  the  error  in  the  conclusion. 
However,  it  must  also  be  pointed  out  that  the  explana- 
tion of  the  returns  in  insurance,  especially  in  fire  insur- 
ance, as  made  by  the  companies,  does  not  always  express 
the  exact  financial  condition  of  the  business.  It  is  often 
pointed  out  by  fire  insurance  companies  that  the  under- 
writing profit  during  the  last  fifty  years  has  often  been 
less  than  i  per  cent,  and  hi  some  years  has  been  nothing. 
This  statement  is  correct,  but  it  is  not  enlightening  as 
to  the  financial  experience  of  the  fire  insurance  com- 
panies. The  underwriting  profit  is  only  the  remainder 
of  the  year's  premiums  after  the  loss  payments  and 
expenses  have  been  deducted.  Policies  are  written 
for  periods  of  from  one  to  five  years  which  under  the 
method  of  calculating  the  reserve  previously  described 
makes  it  impossible  to  take  any  one  year's  experience 
in  fire  insurance  as  a  test  of  the  profitableness  of  the 


282  PRINCIPLES  OF  INSURANCE 

business.  The  ratio  of  losses  to  $100  of  premium  has 
during  the  past  fifty  years  averaged  57.85  per  cent,  and 
the  ratio  of  expenses  to  premium  receipt  has  been  dur- 
ing the  same  period  36.42  per  cent.  Such  a  calculation 
of  profit  on  the  basis  of  mere  underwriting  profit  leaves 
out  of  consideration  the  item  of  interest  earning.  But 
not  all  of  the  interest  earned  can  be  counted  in  deter- 
mining the  actual  profitableness  of  fire  insurance  com- 
panies. The  funds  on  which  such  a  company  has  to 
earn  interest  during  the  year  are  the  capital,  the  sur- 
plus, and  the  reserve.  If  the  company  has,  for  example, 
$1,000,000  of  capital  and  $14,000,000  in  surplus,  and 
declares  a  dividend  of  30  per  cent  on  the  $1,000,000 
stock,  this  30  per  cent  dividend  resolves  itself  into  a 
2  per  cent  dividend  on  the  total  capital  set  aside  for 
conducting  the  business,  to  say  nothing  of  the  risk  in- 
volved from  the  fact  that  the  stockholders  are  liable 
for  an  assessment  on  the  stock  in  the  event  of  a  confla- 
gration, if  they  wish  to  preserve  all  or  a  part  of  the  accu- 
mulated surplus.  However,  this  would  not  be  an  abso- 
lutely accurate  method  of  calculating  the  actual  profit- 
ableness of  the  business.  The  amount  of  capital  which 
a  company  has  invested  in  the  business  has,  from  the 
standpoint  of  calculating  the  earning,  little  significance. 
Its  chief  function  is  in  determining  the  ownership  of  the 
company,  and  only  at  times  of  crises  in  the  affairs  of 
the  concern  does  it  rise  to  importance  in  the  financial 
aspects  of  the  business.  In  an  economic  sense  the  real 
value  of  the  company  is  not  its  capital  value  but  what 
the  business  is  worth  or  what  it  will  sell  for  as  a  going 
concern.  This  going  value  or  proprietary  interest  is 


RELATION  OF  THE  STATE  TO  INSURANCE     283 

determined  by  the  capital,  the  surplus,  and  by  a  per- 
centage usually  about  30  per  cent  of  the  reinsurance 
reserve. 

This  assumes  that  a  fire  insurance  company,  if  in  a 
normal  condition,  can  reinsure  its  business  for  about 
70  per  cent  of  the  reserve.  It  will  be  recognized,  then, 
that  mere  underwriting  profit,  that  is,  the  difference 
between  what  is  paid  in  to  the  company  and  what  is 
paid  out  by  the  company,  is  not  a  full  explanation  of  the 
company's  net  earnings.  If  the  above  described  methods 
of  calculating  the  actual  profitableness  of  the  business 
are  applied  to  the  fire  insurance  companies,  it  will  be 
found  that  no  excessive  returns  have  as  a  whole  been 
received.  If  the  six  largest,  the  six  smallest,  six  medium 
sized  companies,  six  new  and  six  foreign  companies  are 
taken  for  application  of  the  method,  the  following  results 
are  shown :  The  six  largest  United  States  companies 
have  earned  during  the  past  twenty  years  10.1  per  cent, 
ranging  from  a  profit  in  one  year  by  one  company  of 
31.4  per  cent  to  a  loss  in  one  year  by  another  company 
of  49.4  per  cent.  The  rate  of  dividends  for  these  com- 
panies, computed  on  this  accurate  method,  has  averaged 
for  the  twenty  years  5.4  per  cent,  that  is,  they  have  dis- 
tributed of  this  average  earning  of  10.1  per  cent  a  little 
over  one  half  in  dividends  and  have  kept  the  remainder 
in  the  business,  allotting  it  to  the  surplus,  which  means 
that  it  may  all  be  taken  by  a  conflagration.  Applying 
the  same  method  of  calculation  to  the  other  groups, 
results  in  an  earning  of  6.6  per  cent  for  the  six  medium- 
sized  companies  during  the  past  twenty  years,  and  of 
this  3.3  per  cent  was  used  for  dividends.  The  six  small- 


284  PRINCIPLES  OF  INSURANCE 

est  companies  earned  4.5  per  cent  and  distributed 
dividends  of  3.4  per  cent  during  the  period.  Of  the  six 
new  companies  three  earned  nothing  during  the  period ; 
of  the  six  foreign  companies,  three  lost  money  during 
the  period.  On  the  whole  the  investigation  seems  to 
show  that  it  is  likely  to  be  only  the  old  well-established 
companies  which  are  profitable  and  also  that  there  is 
a  close  connection  between  size,  age,  and  success.  In 
the  second  place  it  would  seem  to  be  clearly  shown  that 
the  most  successful  companies  have  been  earning  about 
10  per  cent,  of  which  5  per  cent  has  been  placed  back  in 
the  business.  Ten  per  cent  is  considered  a  very  good 
return  in  most  business,  but  it  must  be  recognized  that 
5  per  cent  is  returned  to  the  business  and  a  risk  of  losing 
all  of  it  is  therefore  incurred.  Some  return  might  be 
justified  on  this  risk.  These  calculations  were  applied 
only  to  the  larger  companies.  In  many  of  the  smaller 
companies  the  investors  could  doubtless  have  secured 
a  better  return  by  investing  their  capital  in  bonds, 
mortgages,  or  stocks  other  than  insurance  stocks. 
Nothing  is  here  said  in  reference  to  expense.  Whether 
the  expense  is  or  is  not  unnecessarily  high  is  an  entirely 
different  question.  All  that  is  here  attempted  is  to 
show  that  the  common  assumption  that  fire  insurance 
is  an  extremely  profitable  business  has  no  basis  in  actual 
facts.  This,  however,  is  not  to  state  that  a  profit  is 
not  made,  even  an  underwriting  profit  from  certain 
states  and  on  certain  classes  of  risks.  It  is  because  of 
the  fact  that  each  state  has  control  over  rates,  and  these 
two  previous  facts  that  a  large  part  of  the  discussion 
and  dispute  arise  in  reference  to  the  rates  and  the  profit 


RELATION  OF  TIJE   STATE  TO  INSURANCE     285 

of  companies.  A  particular  state  or  locality  finds  that 
the  fire  insurance  companies  have  received  a  certain 
amount  of  premiums  from  the  state  or  section  and  have 
paid  in  losses  only  a  fraction  of  this  premium  fund.  It  is 
but  natural  to  conclude  that  the  companies  are  making 
a  large  amount  of  money,  and  to  have  no  great  desire 
to  help  pay  for  the  losses  in  another  state  or  locality  by 
permitting  the  companies  to  charge  the  same  rates. 

In  the  fourth  place  it  is  a  popular  notion  that  life 
insurance  has  in  it  the  primary  elements  of  investment. 
This  popular  notion  has  been  largely  a  result  of  some 
of  the  policies  sold  and  the  zeal  of  life  insurance  agents  in 
selling  insurance  as  well  as  in  the  excessive  competition 
of  companies  for  business.  Insurance  properly  under- 
stood and  sold  can  never  compete  with  other  invest- 
ments. Life  insurance  is  not  an  investing  institution. 
It  can  never  return  to  the  buyer  a  profit.  As  a  protec- 
tion, as  a  mutual  risk-assuming  device,  it  has  been 
greatly  retarded  in  its  true  development  by  having  had 
attached  to  it  many  of  the  appendages  of  an  investment. 

Lastly,  the  fallacy  still  persists  with  many  that  the 
insurance  companies  pay  for  the  losses.  The  truth  is, 
that  the  companies  only  act  as  collecting  agencies  for 
the  policyholders  and  have  no  source  of  income  and 
should  have  none  except  the  premiums  of  the  policy- 
holders  and  the  moderate  rate  of  interest  which  these 
premiums  earn  when  invested  in  long-time  non-specu- 
lative securities.  Nevertheless,  many  holders  of  life 
policies  expect  a  company  to  return  to  them  from  some 
mysterious  source  sums  far  in  excess  of  the  premiums 
paid  and  their  earnings.  In  the  case  of  fire  insurance 


286  PRINCIPLES  OF  INSURANCE 

policies,  many  object  to  becoming  a  coinsurer  with 
the  company  of  their  property,  and  in  many  states  the 
legislatures  have  prohibited  coinsurance  and  have 
enacted  valued  policy  laws,  both  of  which  laws  are 
essentially  based  on  an  assumption,  that  a  particular 
policyholder  may  collect  money  from  a  company '  as 
distinct  from  the  policyholders.  Courts  and  juries  are 
often  ready  to  give  decisions  in  favor  of  a  claimant  against 
an  insurance  company  notwithstanding  that  a  burden 
is  thereby  imposed  upon  other  policyholders  and  not 
upon  the  company.  Accident  policies  are  made  col- 
lectible by  law  in  some  states  in  case  of  suicide  notwith- 
standing that  the  contract  was  never  intended  to  include 
suicide  among  the  list  of  happenings  which  would  make 
the  policy  payable.  The  payment  of  premiums  is 
forgotten  in  the  payment  of  the  loss.  It  is  this  failure 
to  balance  the  many  against  the  few,  the  public  against 
the  individual,  the  long  view  against  the  short  view, 
which  leads  to  so  many  popular  fallacies. 

The  True  Character  of  the  Insurance  Premium.  - 
It  must  never  be  forgotten  that  the  insurance  business 
is  peculiar  in  this  one  particular;  the  property  of 
insurance  companies  is  not  made  up  of  tangible  or  even 
intangible  things  distinct  from  the  policyholders.  The 
property  is  the  premiums  of  the  policyholders,  exchanged 
for  a  piece  of  paper,  expressing  a  contract.  Even  the 
securities  held  by  the  company  are  either  actually  or 
potentially  the  property  of  the  policyholders.  The 
officials  and  agents  are  in  a  true  sense  the  hired  employees 
of  the  policyholders.  And  this  is  true  regardless  of  the 
mutual  or  stock  character  of  the  company.  Insurance 


RELATION  OF  THE  STATE  TO  INSURANCE    287 

is  even  more  than  a  public  business  like  a  railway.  A 
railway  company  owns  private  property  which  is  used 
in  the  service  of  the  public,  but  an  insurance  company 
is  service.  It  has  no  property  other  than  the  service 
it  renders  to  the  owners  —  the  policyholders.  In- 
surance of  all  kinds  is  essentially  mutual,  whatever 
modified  forms  this  mutuality  may  take.  It  is  but  the 
voluntary  contribution  of  the  many  to  help  bear  the  mis- 
fortunes of  the  few.  Self-interest  plays  only  a  small 
part  in  that  the  bearer  of  the  misfortune  is  unknown  at 
the  time  the  agreement  is  made.  If  a  third  party  is 
introduced  in  addition  to  the  individual  members  and 
the  group  —  the  first  and  second  parties  —  it  is  only 
for  the  purpose  of  convenience,  in  that  detailed  and 
necessary  work  in  operating  the  system  is  assigned  to  an 
employee,  who  becomes  a  middleman.  This  middleman 
simply  collects  the  premiums  and  guarantees  the  pay- 
ment of  the  losses,  thus  relieving  the  members  of  the 
group  of  any  risk  of  assessments  or  premiums.  Thus 
arises  what  is  called  stock  insurance,  the  company  sell- 
ing a  quasi  commodity  —  indemnity ;  but  even  so,  the 
business  continues  essentially  mutual.  No  amount  of 
surplus  and  assets  would  make  possible  a  continuation 
of  business  or  even  the  payment  of  the  indemnity,  if 
there  were  not  this  group  of  the  insured,  mutually  bound 
together  by  the  desire  to  protect  each  other  against 
future  misfortune. 

Impelled  by  this  motive  of  cooperation  to  protect 
each  other,  the  life  and  fire  insurance  business  has  devel- 
oped until  it  affects  either  directly  or  indirectly  a  large 
percentage  of  the  people  of  the  United  States. 


The  stock  fire  insurance  companies,  alone,  have  risks 
in  the  United  States  of  over  sixty  billions  of  dol- 
lars. There  is  an  actual  annual  average  loss  of  over 
$200,000,000.  Not  only  is  this  actual  loss  distributed, 
but  the  distribution  of  the  potential  indemnity  brings 
a  state  of  security  to  the  insured.  It  lies  at  the  very 
foundation  of  the  credit  system. 

In  life  insurance  over  twenty  billion  dollars  of  insur- 
ance is  guaranteed  by  the  ordinary  and  industrial  com- 
panies, excluding  assessment  and  other  companies,  just 
as  mutual  companies  were  excluded  in  the  case  of  fire 
insurance.  It  is  thus  impossible  to  measure  either 
the  volume  or  importance  of  insurance. 

Is  Insurance  a  Public  or  a  Private  Business  ?  —  Two 
questions  in  relation  to  this  business  which  has  so  won- 
derfully developed  and  which  so  intimately  affects  so 
many  people  are :  first,  Is  it  a  public  or  private  business, 
and  second,  Is  it  a  competitive  business?  The  answer 
given  to  these  two  questions  largely  determines  the  rela- 
tion of  the  government  to  insurance.  The  first  ques- 
tion, whether  insurance  is  a  private  or  public  business, 
is  assuming  large  importance  at  present,  due  to  the  dis- 
cussion centering  about  rates.  If  insurance  is  a  public 
business,  then  it  follows  that  the  government  not  only 
has  a  very  extensive  control  over  the  prices  charged  for 
the  indemnity  and  protection  but  also  more  substantial 
grounds  exist  for  arguing  that  it  should  be  made  a  state 
business,  if  not  a  state  monopoly.  Whatever  may  be 
the  individual  opinion  as  to  the  public  or  private  nature 
of  insurance,  as  a  matter  of  fact  the  question  as  a  purely 
legal  one  has  been  decided  by  the  Supreme  Court  of  the 


RELATION   OF  THE   STATE  TO  INSURANCE     289 

United  States  in  the  case  of  the  German  Alliance  In- 
surance Company  v.  Kansas,  decided  in  1914.  (24 
U.  S.  Sup.  Ct.  Rep.  612.)  It  was  here  held  by  a  ma- 
jority of  the  court  that  insurance  was  a  public  business. 
Business,  said  the  court,  may  rise  from  a  private  to  a 
public  concern. 

The  decision  pointed  out  that  the  risks  in  insurance  are 
scattered  over  a  large  territory,  and  that  therefore  insur- 
ance rates  are  raised  to  a  public  issue.  Contracts  of 
insurance,  therefore,  have  greater  public  consequence 
than  contracts  between  individuals  to  do  or  not  to  do  a 
particular  thing  whose  effect  stops  with  the  individuals. 

"  To  the  contention  that  the  business  is  private," 
said  the  court,  "  we  have  opposed  the  conception  of 
public  interest.  We  have  shown  that  the  business  of 
insurance  has  very  definite  characteristics,  with  a  reach 
of  influence  and  consequences  beyond  and  different 
from  that  of  the  ordinary  business  of  the  commercial 
world,  to  pursue  which  a  greater  liberty  may  be  asserted. 
The  transactions  of  a  private  character  are  independent 
and  individual,  terminating  in  their  effect  with  the 
instances.  The  contracts  of  insurance  may  be  said  to 
be  inter-independent.  They  cannot  be  regarded  singly, 
or  isolatedly,  and  the  effect  of  the  regulation  is  to  create 
a  fund  of  insurance  and  credit,  the  companies  becoming 
the  depositories  of  the  money  of  the  insured,  possessing 
greater  power  thereby  and  charged  with  greater  re- 
sponsibility." 

It  was  pointed  out  that  the  power  to  regulate  inter- 
state commerce  existed  long  before  the  enactment  of 
the  interstate  commerce  law.  That  power,  it  said, 


ago  PRINCIPLES   OF  INSURANCE 

however,  was  exerted  "  only  when  the  size,  number,  and 
influence  of  these  agencies  had  so  increased  and  devel- 
oped as  to  seem  to  make  it  imperative." 

Is  Insurance  a  Competitive  Business  ? —  As  to  the 
second  important  question;  namely,  Is  insurance  a 
competitive  business,  there  would  not  seem  to  be  reason 
for  such  extreme  difference  of  opinion  as  exists,  if  the  real 
character  of  insurance  is  understood.  There  are  two 
aspects  to  this  question.  Confusion  and  misunder- 
standing result  because  these  two  aspects  of  the  ques- 
tion have  not  been  clearly  kept  in  mind.  The  first 
aspect  of  the  question  is  whether  as  a  matter  of  fact 
monopoly  exists.  The  second  aspect  of  the  question  is, 
Is  the  character  of  the  business  such  that  it  should  be 
considered  a  monopoly ;  that  is,  Does  its  conduct  invite 
and  secure  a  play  of  the  competitive  forces  in  price 
making  as  in  the  ordinary  competitive  businesses  ?  The 
first  question  is  easily  answered  by  stating  that  in  1914 
there  were  about  253  different  life  insurance  companies 
in  business  in  the  United  States,  and  at  the  same  date 
there  were  about  605  fire  insurance  companies.  New 
companies  are  continually  being  organized.  There  are, 
therefore,  different  units  selling  this  service,  and  monop- 
oly could  only  exist  by  proving  that  in  each  case  of 
these  253  and  605  insurance  companies,  there  was  agree- 
ment as  to  the  prices  which  were  to  be  charged.  This 
would  need  to  be  proven  to  exist  among  companies  of 
such  opposite  interests  as  stock  and  mutual  companies. 
The  most  superficial  student  of  monopoly  knows  that 
it  would  be  impossible  to  maintain  an  agreement  re- 
garding prices  among  such  a  large  number  of  individual 


RELATION  OF  THE   STATE  TO  INSURANCE     291 

units.  It  is  often  argued  that  a  monopoly  must  exist 
by  some  secretly  maintained  agreement  on  account  of 
the  fact  that  comparatively  few  large  life  and  fire  insur- 
ance companies  have  recently  been  established.  The 
greater  number  of  such  efforts  have  failed.  Statistics 
show  that  no  company  of  the  first  rank  has  gained  a 
footing  in  fire  insurance  during  the  past  thirty  years, 
and  further  that  since  1841  of  fire  and  marine  insur- 
ance companies,  2249  have  either  failed  or  gone  out  of 
business  in  the  United  States.  Likewise,  statistics 
show  that  274  life  companies  have  either  failed  or  gone 
out  of  business  since  1850.  But  this  is  to  be  explained  by 
the  character  of  the  business.  This  brings  us  to  the 
second  aspect  of  the  question :  viz.  Is  insurance  by  its 
character  suited  to  the  principles  of  competition?  This 
is  largely  determined  by  the  extent  of  control  which 
each  of  the  producers  has  over  the  cost  of  his  product, 
and  by  the  control  that  the  consumer  has  over  his  de- 
mand for  the  product.  As  regards  the  producer  — 
the  insurance  company  —  it  is  recognized  that  the  life 
insurance  company  has  no  control  over  the  mortality 
rate  nor  does  the  fire  insurance  company  have  any 
considerable  control  over  the  burning  rate.  These 
factors,  the  mortality  and  burning  rate,  are  by  far  the 
most  important  ones  in  determining  the  price  for  the 
producer.  There  is  only  left  for  determination,  operat- 
ing costs,  and  some  of  these,  such  as  taxes,  are  also  fixed 
for  the  producer.  Again,  certain  minor  fixed  charges 
exist.  There  remain  only  about  one  third  of  the  total 
costs,  —  which  may  be  denominated  variable  costs,  — 
over  which  the  individual  producers  —  the  companies 


292  PRINCIPLES  OF  INSURANCE 

—  have  control.  On  the  side  of  the  consumer,  the  buyer 
of  insurance,  there  is  little  control  over  the  price  and 
little  choice  of  product.  He  can  have  but  slight  effect 
on  the  mortality  and  burning  rate,  and  thus  bargain 
in  his  purchase.  He  has  no  choice  of  product  for  there 
is  no  substitute  for  insurance  protection.  As  the  court 
well  remarked  in  the  Kansas  case  previously  noted : 

"  We  may  venture  to  observe  that  the  price  of  insur- 
ance is  not  fixed  over  the  counters  of  the  companies  by 
what  Adam  Smith  called  the  higgling  of  the  market, 
but  forms  in  the  councils  of  the  underwriters,  promul- 
gated in  schedules  of  practically  controlling  constancy 
which  the  ^applicant  for  insurance  is  powerless  to  oppose 
and  which  therefore  has  led  to  the  assertion  that  the 
business  of  insurance  is  of  monopolistic  character  and 
that '  it  is  illusory  to  speak  of  a  liberty  of  contract.' 

"It  is  in  the  alternative  presented  of  accepting  the 
rate  of  the  companies,  or  refraining  from  insurance, 
business  impelling  if  not  compelling  it,  that  we  may  dis- 
cover the  inducement  of  the  Kansas  statute." 

Evil  Effects  of  Excessive  Competition.  —  The  results 
of  competition  have  been  disastrous  enough  in  both 
life  and  fire  insurance  as  proved  by  their  effects.  We 
need  not  theorize  about  this  matter.  In  life  insurance 
it  has  meant  among  other  things  the  organization  of 
companies  on  unscientific  plans  which  in  their  operation 
have  brought  loss  to  many.  It  has  meant  unnecessary 
expense  in  an  effort  to  secure  business,  and  a  perversion 
of  insurance  to  investment,  the  issuing  of  semi-deceptive 
policies,  the  payment  of  unduly  high  salaries,  commis- 
sions, and  other  accompaniments  of  unrestrained  com- 


RELATION  OF  THE   STATE  TO  INSURANCE     293 

petition.  In  fire  insurance  the  past  and  still  too  preva- 
lent rate  wars  furnish  ample  evidence  of  the  evil  effects 
of  competition. 

"  The  universal  effect  of  such  periods  of  rate  wars 
in  fire  insurance  wherever  and  whenever  they  have 
occurred  has  been  a  cutting  of  rates  to  a  point  that  was 
below  the  actual  cost  of  the  indemnity.  If  the  rate 
war  had  been  general,  this  would  have  meant  the  ulti- 
mate failure  of  the  company,  and  rate  wars  of  even 
local  character  lead,  if  long  continued,  to  the  dissolution 
of  the  smaller  and  weaker  companies.  The  effect  on 
all  companies  is  weakening.  The  policyholder,  to  be 
sure,  gets  for  a  time  his  insurance  very  cheaply;  too 
cheaply,  for  the  weakening  of  the  companies  is  not  in 
the  long  run  and  on  the  whole  an  economic  good,  for 
there  is  just  so  much  less  protection  behind  the  insured 
in  case  of  a  conflagration.  The  mutual  character  of 
insurance  is  so  strong  that  nothing  which  tends  to  pro- 
duce inferior  protection  can  be  for  the  public  good. 
It  has  not  done  the  policyholder  any  good  to  get  cheap 
insurance  if,  when  the  time  comes,  the  protection  is 
found  to  be  worthless. 

"  But  this  is  not  all.  In  a  state  of  open  competition 
the  rates  adjust  themselves  not  to  the  hazards  but  largely 
to  the  strength  of  the  insured,  so  that  the  man  of  influ- 
ence, whose  patronage  is  desired,  will  get  his  insurance 
too  cheaply,  as  against  the  small  man  who  is  not  in  a 
position  to  drive  a  sharp  bargain.  That  is,  competition 
results  in  discrimination." 

Such  in  brief  is  the  elementary  character  of  insurance. 
It  is  now  for  us  to  discuss  the  legal  status  of  insurance 


294  PRINCIPLES  OF  INSURANCE 

as  it  expresses  itself  not  only  in  the  law  and  in  the  court 
decisions  but  also  in  the  regulation  of  the  business. 

Supreme  Court  Decisions  on  Insurance.  —  From  a 
long  line  of  decisions  beginning  with  Paul  v.  Virginia, 
and  including  such  important  cases  as  Nathan  v.  Louisi- 
ana, Ducat  v.  Chicago,  Liverpool  Insurance  Company 
v.  Massachusetts,  Philadelphia  Fire  Association  v. 
New  York,  Hooper  v.  California,  Noble  v.  Mitchell, 
New  York  Life  Insurance  Company  v.  Cravens,  Nutting 
v.  Massachusetts,  Equitable  Life  Society  Company  v. 
Clements  to  the  late  cases  of  the  New  York  Life  Insur- 
ance Company  v.  Deer  Lodge  County,  Montana,  and 
the  German- American  Insurance  Company  v.  Kansas, 
several  points  in  the  legal  status  of  insurance  have  been 
incontrovertibly  decided. 

First,  insurance  is  not  commerce  nor  is  the  policy  an 
instrumentality  of  commerce.  It  therefore  is  a  sub- 
ject for  complete  state  control,  subject  only  to  such  lim- 
itations as  the  Federal  Constitution  lays  down  for  the 
control  of  any  property. 

Second,  insurance  has  certain  characteristics  which 
make  it  a  public  business  for  purposes  of  rate  control. 
A  state  can  therefore  regulate  insurance  rates  to  the 
same  extent  that  it  can  regulate  the  rates  of  any  business 
of  a  public  character. 

Third,  the  insurance  contract  is  a  personal  contract, 
a  mere  indemnity  for  a  consideration  against  the  hap- 
pening of  some  contingent  event  which  may  bring 
detriment  to  life  or  property.  Its  character  is  the  same, 
no  matter  what  the  event  insured  against,  whether 
fire  or  hurricane,  acts  of  man,  or  acts  of  God,  storms  on 


RELATION   OF  THE   STATE  TO  INSURANCE     295 

land  or  sea,  death  or  lesser  accidents.  Nor  does  the 
character  of  the  contracts  change  by  their  numbers  or 
the  residence  of  the  parties.  It  is  of  course  true  that 
the  ordinary  life  insurance  contract  is  not  peculiarly 
one  of  indemnity.  It  is  also  true  that  the  courts  of 
some  states  have  refused  to  apply  the  fire  insurance 
contract  as  one  of  indemnity. 

Efforts  to  Secure  Federal  Regulation  of  Insurance.  — 
Numerous  efforts  have  been  made  to  bring  insurance 
under  the  regulation  of  the  Federal  Government. 
Elizur  Wright,  the  first  insurance  commissioner  of 
Massachusetts,  made  such  a  recommendation  in  1865, 
and  in  1866  a  bill  was  introduced  in  Congress  for  this 
purpose.  Several  other  bills  for  the  same  purpose 
have  been  introduced  from  time  to  time  until  it  was 
finally  recognized  that  such  a  law  would  in  view  of  the 
decisions  of  the  Supreme  Court  be  unconstitutional. 
It  is  scarcely  probable,  in  view  of  this  court's  decision, 
that  Congress  could  make  insurance  interstate  com- 
merce by  calling  it  such,  for  the  court  remarked  in  the 
early  case  •  of  McCullough  v.  Maryland  (4  Wheaton 
316)  "  Should  Congress  under  the  pretext  of  executing 
its  powers,  pass  laws  for  the  accomplishment  of  objects 
not  entrusted  to  the  government,  it  would  become  the 
painful  duty  of  this  tribunal,  should  a  case  requiring 
such  a  decision  come  before  it,  to  say  that  such  an  act 
was  not  the  law  of  the  land."  The  only  hope,  there- 
fore, especially  since  the  later  decision  of  the  Deer  Lodge 
case,  rests  in  securing  an  amendment  to  the  Constitu- 
tion which  will  bring  insurance  under  the  regulation  of 
the  Federal  Government.  Such  an  amendment  was 


296  PRINCIPLES   OF   INSURANCE 

proposed  to  Congress  in  1914,  but  it  has  not  yet  received 
affirmative  action.  The  advantages  of  federal  regula- 
tion are  among  others : 

Advantages  of  Federal  Regulation  of  Insurance.  - 
First,  there  would  be  one  uniform  code  of  regulation. 
Some  uniformity  in  insurance  control  has  been  secured 
by  the  adoption  by  one  state  of  another  state's  laws  and 
through  the  conference  of  state  insurance  commissioners, 
but  there  is  yet  very  great  difference  in  the  detail 
requirements. 

Second,  there  would  be  one  standard  policy  for  each 
kind  and  class  of  insurance. 

Third,  one  official  examination. 

Fourth,  one  uniform  method  of  valuing  policies. 

Fifth,  a  marked  decrease  in  the  expense  of  regulating 
insurance. 

Sixth,  one  uniform  method  of  taxation,  although  the 
state  would  have  a  coordinate  power  of  taxation,  as  in 
the  case  of  railways. 

The  disadvantages,  theoretical  and  practical,  are, 
among  others : 

First,  the  danger  of  centralized  political  control. 
This,  however,  would  not  seem  to  be  serious. 

Second,  the  danger  of  control  by  the  insurance 
officials  through  such  a  centralized  bureau  as  compared 
with  the  opportunity  at  present  of  controlling  them 
through  the  many  state  departments. 

Third,  the  difficulty  of  securing  the  repeal  or  amend- 
ment of  unwise  legislation.  If  at  present  a  company 
is  dissatisfied  with  the  laws  of  a  particular  state  or  the 
administrative  regulations  of  the  insurance  commis- 


RELATION  OF  THE   STATE  TO  INSURANCE     297 

sioner,  it  can  withdraw  from  doing  business  in  that 
state. 

Fourth,  the  very  great  difficulty  in  prescribing  reg- 
ulation, especially  as  regards  rates  which  would  be 
applicable  to  the  widely  differing  conditions  in  the  dif- 
ferent sections  of  a  country  so  large  as  the  United 
States.  This  would  be  more  difficult  in  the  case  of 
fire  than  life  insurance  rates. 

Fifth,  the  opposition  that  exists  in  some  quarters  of 
further  centralizing  control  of  business  in  the  Federal 
Government  at  the  expense  of  the  states. 

Sixth,  the  practical  objection  which  the  people  of 
the  states  and  their  representatives  in  Congress  would 
have  in  giving  up  such  a  lucrative  source  of  revenue  for 
the  states  by  the  loss  of  a  part  or  all  the  revenue  from 
the  taxation  of  insurance  companies. 

The  Basis  of  State  Regulation.  —  Since  the  state  is 
responsible  for  the  existence  of  corporations,  and  since 
the  rights  granted  to  insurance  corporations  lead  to  the 
creation  of  trust  funds,  it  follows  that  the  state  must 
see  to  it  that  these  sacred  obligations  are  met  by  the 
creature  which  it  has  called  into  existence  —  the  cor- 
poration. At  the  tune  of  the  adoption  of  the  Consti- 
tution and  for  many  years  later,  the  general  principle 
of  little  government  interference  in  industry  was  fol- 
lowed. Few  evils,  so  far  as  insurance  was  concerned, 
resulted,  for,  as  we  have  seen,  little  of  insurance  was 
transacted  previous  to  1835. 

Character  of  Early  Regulation. — Whatever  supervision 
there  was  of  the  insurance  business  was  at  first  primarily 
for  the  purpose  of  obtaining  a  basis  for  raising  revenue, 


298  PRINCIPLES  OF  INSURANCE 

and  this,  it  may  be  added,  is  still  an  important  reason 
for  supervision.  In  the  licensing  of  companies  and  the 
prevention  of  fraudulent  companies  from  operating 
within  a  state,  the  interest  of  policyholders  was  prob- 
ably of  secondary  importance.  In  time,  however,  as 
the  business  grew  in  size  and  complexity,  there  was  a 
growing  realization  that  the  state  must  take  a  more 
active  part  in  regulating  a  business  which  affected  so 
large  a  number  of  people.  In  addition,  there  had  been 
organized  many  companies  of  a  fraudulent  character 
between  the  years  1825  and  1850,  or,  if  not  fraudulent, 
organizations  which  operated  upon  the  unscientific 
plan  of  assessmentism.  The  evils  which  resulted  from 
the  operation  of  these  companies  were  probably  the 
most  direct  cause  for  the  demand  to  arise,  that  the  busi- 
ness of  insurance  be  more  closely  supervised  by  the 
state.  Previous  to  1855  the  state  had  been  satisfied 
to  lay  down  in  general  laws  the  terms  under  which  an 
insurance  company  could  be  organized  and  operated. 
No  detailed  reports  were  required  to  be  filed  and  no 
reserves  to  be  maintained. 

Massachusetts  was  the  first  state  to  establish  a  state 
insurance  department.  This  was  done  in  1855,  and  the 
action  of  Massachusetts  was  followed  by  New  York  in 
1859,  by  Connecticut  in  1865,  by  Ohio  in  1867,  and  by 
Michigan  in  1871.  Every  state  in  the  Union  now  super- 
vises the  insurance  business,  although  in  some  states  the 
department  is  only  a  separate  bureau  under  the  direction 
of  some  other  department  of  state.  Where  there  is  no 
separate  department,  the. work  is  usually  placed  under 
the  charge  of  the  auditor,  treasurer,  or  secretary  of  state. 


RELATION  OF  THE   STATE  TO  INSURANCE     299 

The  departments  or  bureaus  are  supported  by  fees 
and  taxes  collected  from  the  insurance  companies,  but 
the  amount  of  funds  collected  bears  no  definite  relation 
to  the  cost  of  maintaining  the  department. 

Although  Massachusetts  established  her  insurance 
department  in  1855,  no  standards  of  solvency  were 
required  until  1861.  No  other  state  established  such 
standards  until  after  the  Civil  War. 

How  Insurance  Is  Regulated.  —  Insurance  is,  there- 
fore, now  regulated  in  the  following  manner : 

(a)  By  the  general  laws  governing  all  business  so  far 
as  they  apply  in  their  general  terms  to  insurance. 

(b)  By  special  laws,  enacted  to  govern  the  organiza- 
tion, operation,  and  liquidation  of  insurance  companies. 

(c)  By  the  establishment  of  the  office  of  a  commis- 
sioner or  superintendent  of  insurance  who  is  given  in 
the  laws  of  many  states  wide  discretionary  powers  of 
an  administrative  character  in  addition  to  his  special 
statutory  powers  of  enforcing  the  insurance  laws. 

This  Commissioner  or  Superintendent  is  in  practically 
all  cases  an  appointive  official,  that  is,  the  office  is  a 
political  one.  The  result  is  that  the  official  frequently 
changes.  During  a  period  of  fifteen  years,  ending  with 
1914,  only  two  such  officials  continued  in  office.  Fre- 
quently the  appointed  official  has  no  special  insurance 
knowledge  which  qualifies  him  for  the  office.  Yet  the 
results  are  not  as  serious  as  might  at  first  be  supposed. 
The  department  under  his  supervision  has  become  in 
most  states  a  large  one  with  the  subordinates  in  charge 
of  its  divisions  well  fitted  by  training  and  experience. 
These  department  heads  often  continue  from  commis- 


300  PRINCIPLES  OF  INSURANCE 

sioner  to  commissioner's  term  of  office  and  if  the  ap- 
pointed commissioner  is  a  man  of  good  judgment,  he 
soon  becomes  able  with  the  aid  of  these  subordinates 
to  render  good  service  to  the  insured  public,  the  legis- 
lature, and  the  companies.  Doubtless  better  results 
would  be  secured  by  longer  tenure  in  office,  since  the 
commissioner  is  often  replaced  just'  at  the  time  when 
he  has  become  well  informed  and  able  to  render  directly 
better  service,  yet  the  actual  results  under  the  appoin- 
tive system  are  not  as  serious  as  is  sometimes  argued. 
It  does. not  follow  by  any  means  that  "  an  insurance 
man  "  would  make  the  best  insurance  commissioner  for 
a  state.  The  particular  duties  of  the  insurance  com- 
missioner cover  a  wide  range  of  subjects. 

There  are  in  most  states  special  laws  which  govern 
the  organization  of  insurance  companies.  The  terms 
under  which  such  companies  can  be  organized  differ 
according  to  the  character  of  the  organization,  such, 
for  example,  as  the  special  laws  governing  the  organiza- 
tion of  a  fraternal  society  or  the  ordinary  level  premium 
life  insurance  company.  Since  the  latter  companies 
do  the  greatest  amount  of  the  business  and  also  are  the 
ones  to  which  regulation  is  chiefly  directed,  our  descrip- 
tion of  the  regulation  of  the  organization  and  operation 
of  life  insurance  companies  may  be  taken  as  applicable 
to  this  kind  of  a  company. 

A  very  general  requirement  for  such  corporations  is 
that  they  must  deposit  with  the  treasurer  of  state 
securities  to  the  value  at  least  of  $100,000.  This  is 
a  requirement  for  both  stock  and  mutual  companies 
proposing  to  insure  lives  on  the  level  premium  plan. 


RELATION  OF  THE   STATE  TO  INSURANCE    301 

Massachusetts  made  this  requirement  of  the  New 
England  Mutual,  which  was  organized  in  1835,  twenty 
years  before  her  state  insurance  department  was  estab- 
lished. 

In  some  states  there  is  a  provision  requiring  the 
retirement  of  the  stock  of  the  proposed  mutual  company, 
with  a  maximum  interest  paid  upon  the  funds  which 
have  been  advanced  by  the  incorporators  of  the  com- 
pany as  a  necessary  capital  to  pay  the  large  initial  ex- 
penses of  starting  the  company  in  business. 

The  laws  governing  the  organizations  of  companies 
differ,  of  course,  in  the  various  states,  but  the  general 
purpose  in  all  cases  is  to  lay  down  such  principles  as 
will  insure  the  ability  of  the  companies  to  meet  their 
obligations. 

The  value  of  a  deposit  as  a  guarantee  fund  after  the 
company  is  a  going  concern  is  very  questionable,  since 
the  company  is  setting  aside  a  reserve  and  probably  a 
surplus.  If  the  assets  of  a  company  are  carefully  in- 
spected and  the  transactions  of  the  company  super- 
vised, this  would  seem  to  give  all  the  required  safety, 
so  far  as  solvency  is  concerned. 

If  a  company  organized  in  one  state  desires  to  do  busi- 
ness in  another  state,  it  must  comply  with  the  condi- 
tions laid  down  by  the  state  which  it  enters.  Insur- 
ance is  not  commerce,  according  to  the  decision  of  the 
Supreme  Court,  and  the  various  states  may  lay  down 
in  detail  the  conditions  under  which  a  company  is 
permitted  to  do  business.  They  must  satisfy  the 
authorities  of  the  state  that  they  are  able  to  meet  their 
obligations.  A  copy  of  the  charter,  granted  by  the 


302  PRINCIPLES  OF  INSURANCE 

parent  state,  as  well  as  a  certificate  showing  that  it  is 
authorized  to  do  business,  is  filed;  also  a  statement 
of  its  financial  condition  showing  income,  disbursements, 
and  a  certificate  showing  that  it  has  deposited  with  the 
officials  of  the  home  state  a  deposit,  usually  a  minimum 
one  of  $100,000.  It  also  files  the  valuation  of  its  policies 
made  by  the  insurance  department  of  the  home  state 
and  a  copy  of  all  the  policies  which  it  proposes  to  write. 
Its  agents  appointed  or  to  be  appointed  must  secure  a 
license  from  the  proper  authority.  Other  information 
bearing  upon  the  character  of  the  company  and  its 
method  of  operation  is  secured  by  the  proper  state 
authority,  usually  the  state  insurance  commissioner. 
If  all  this  information  seems  to  satisfy  the  state  laws, 
the  company  is  admitted  by  a  certificate  from  the  com- 
missioner of  insurance  to  do  business  in  the  state.  The 
admitted  company  is  then  subject  in  its  operation  to 
the  laws  of  the  state  on  insurance.  Some  states  intrust 
very  large  powers  to  the  commissioner  of  insurance, 
while  others  lay  down  in  detail  the  requirements  for 
transacting  the  insurance  business  and  require  the 
commissioner  to  execute  these  laws  with  little  discre- 
tionary powers.  In  either  case  the  courts  of  the  state 
can  restrain  the  officials  from  violating  the  principles  of 
equity. 

Examinations  of  Insurance  Companies.  —  In  most 
states  the  certificate  of  the  commissioner  of  insurance 
regarding  the  condition  of  the  company  is  accepted  in 
other  states,  but  an  examination  of  a  foreign  company 
can  be  made  at  any  time,  and  such  examinations,  al- 
though not  infrequent  in  the  past,  are  becoming  less 


RELATION  OF  THE   STATE  TO  INSURANCE    303 

frequent.  One  of  the  most  important  committees  of 
the  National  Association  of  Insurance  Commissioners 
is  the  committee  on  examinations.  This  committee 
acts  as  a  clearing  house  of  information  for  the  various 
state  departments  of  insurance.  It  has  already  done 
away  with  some  of  the  evils  connected  with  the  numer- 
ous and  sometimes  unnecessary  examinations  made  by 
numerous  states.  The  examinations  made  by  this  com- 
mittee are  accepted  in  many  cases  by  the  state  depart- 
ments, although,  of  course,  any  state  has  the  right  to 
conduct  a  separate  examination.  The  examinations 
made  by  this  committee  and  used  by  the  various  state 
departments  do  not  refer  to  the  annual  examinations, 
but  to  those  comprehensive  examinations  of  a  com- 
pany's business  which  are  made  from  time  to  time, 
especially  when  suspicion  arises  concerning  the  conduct 
of  a  company's  affairs.  Such  examinations  would 
naturally  be  of  companies  doing  business'  in  several 
states  at  the  particular  time. 

Independent  of  these  special  examinations  each  state 
makes  an  examination  of  its  own  companies.  In 
some  states  this  examination  is  required  every  year; 
in  other  states  every  two  or  three  years.  This 
annual,  biennial,  or  triennial  examination  by  the 
state  department  ordinarily  concerns  itself  with  an 
examination  of  the  transactions  of  the  company 
during  the  preceding  calendar  year.  The  examiners 
take  the  last  annual  report  and  verify  it.  The  items  of 
income  and  disbursement  are  checked  from  the  com- 
pany's books.  The  assets  are  inspected ;  all  mortgages 
are  inspected  as  to  title  and  their  proportion  to  the  value 
r 


304  PRINCIPLES  OF  INSURANCE 

of  the  property ;  the  cash  in  office  and  banks  is  checked ; 
and  care  is  exercised  to  discover  any  weakness  or  any 
statutory  violations  of  the  investments.  The  liabilities 
must  also  be  carefully  investigated. 

State  Comity  in  Regulation  Insurance.  —  The  prin- 
ciple of  state  comity  applies  in  many  particulars,  but 
it  has  far  from  accomplished  complete  uniformity. 
The  National  Association  of  Insurance  Commissioners 
has  done  much  in  establishing  uniformity  in  certain 
directions,  such,  for  example,  as  providing  uniform 
blanks  upon  which  a  company  reports  its  condition  to 
the  insurance  department.  In  many  other  cases,  es- 
pecially taxation,  no  uniformity  is  found.  It  is  also 
generally  true  that  home  companies  are  favored  over 
those  of  other  states  in  one  way  and  another.  A  favor- 
ite method  is  by  a  lower  rate  of  taxation  or  no  taxation 
at  all  on  premium  receipts. 

Standards  of  Solvency.  —  The  state  has  laid  down 
certain  standards  of  solvency  by  requiring  the  use  of 
one  of  the  accepted  mortality  tables,  and  the  valuation 
of  policies  must  be  made  according  to  that  table  with 
interest  at  a  specified  rate  per  cent.  In  determining  the 
reserve  liability  of  a  life  insurance  company  the  state 
insurance  department  generally  uses  mean  —  or  mid- 
year —  reserves  on  the  assumption  that  policies  issued 
uniformly  throughout  the  year  are  all,  on  the  average, 
issued  July  first  of  that  year,  and  hence  when  the  valua- 
tion of  a  company's  policies  is  made,  as  of  December 
thirty-first  of  any  year,  the  policies  are  all  at  their  mid- 
year. The  midyear  or  mean  reserves  are  obtained  by 
taking  the  half  sum  of  the  reserves  at  the  beginning  and 


RELATION  OF  THE  STATE  TO  INSURANCE    305 

end  of  each  year  on  the  assumption  that  a  full  annual 
premium  is  paid  on  every  policy.  Consequently,  deferred 
premiums  to  complete  a  full  policy  year  are  allowed  in  the 
assets.  In  industrial  insurance  the  mean  reserves  just 
referred  to  are  reduced  by  one  half  a  net  annual  pre- 
mium for  a  given  kind  and  age,  and  deferred  premiums 
are  not  allowed  in  the  assets.  On  account  of  the  heavy 
lapses  in  industrial  insurance  some  reduction  is  usually 
made  on  first  year  reserves  —  about  one  half  —  and 
on  second  year  reserves  about  one  quarter. 

In  valuing  assets  certain  rules  are  laid  down  for  valu- 
ing stocks  and  bonds.  The  market  value  on  December 
thirty-first  has  generally  been  used,  but  in  some  cases  the 
amortization  plan  has  been  adopted,  by  which  the  values 
do  not  fluctuate  with  the  market,  but  increase  or  decrease 
uniformly  to  par  value  so  as  to  yield  the  same  effective 
rate  of  interest  throughout  the  period.  Home  office 
buildings  and  real  estate  owned  by  the  company  are 
valued  by  the  local  appraisers  who  know  the  value  of 
the  property. 

Regulation  as  to  Kinds  of  Business.  —  A  require- 
ment of  many  states  is  that  a  company  is  not  per- 
mitted to  write  both  participating  and  non-participating 
policies  or,  if  both  kinds  are  written,  it  is  required  that 
they  be  kept  separate  in  the  bookkeeping  of  the  com- 
pany. The  tendency  is  for  stock  companies  to  write 
non-participating  policies  and  mutual  companies  to 
write  participating  policies.  It  was  urged  that  the 
evidence  in  the  insurance  investigation  beginning  in 
1905  showed  that  in  actual  practice  the  equity  of  each 
kind  of  policyholders  was  not  observed. 


306  PRINCIPLES  OF  INSURANCE 

Dividend  Distributions.  —  Annual  distribution  of  divi- 
dends is  a  very  general  requirement.  Standard  provi- 
sions are  required  in  all  policies.  These  have  to  do  with 
cash  surrender  values,  options  in  settlement,  loans, 
lapses,  payment  of  premiums,  and  claims  and  many 
other  subjects  which  are  of  general  interest  to  all  pos- 
sessors of  an  insurance  policy. 

Regulation  as  to  Investments.  —  The  subject  of 
investments  is  one  upon  which  there  has  been  a  great 
amount  of  legislation.  Not  only  has  the  state  prohib- 
ited certain  kinds  of  investments,  as,  for  example,  the 
permanent  possession  of  real  estate,  but  it  has  further 
limited  them  by  specifying  in  what  kind  of  securities 
the  assets  can  be  invested.  This  kind  of  regulation 
was  adopted  in  many  states  before  the  establishment 
of  the  insurance  departments,  since  the  importance  of 
having  these  funds  securely  invested  was  early  recog- 
nized. The  first  restrictions  were  chiefly  applicable  to 
the  original  deposit,  but  by  1875  a  number  of  states 
had  restricted  the  investments  of  the  general  assets. 
At  present  the  restrictions  as  to  the  character  of  the 
securities  differ  considerably  in  the  different  states. 
In  all  states  investments  in  government  bonds  are 
permitted,  although  a  few  states  limit  the  investment 
in  bonds  of  other  than  the  home  state.  Some  con- 
fine mortgage  loans  to  the  home  state  of  the  com- 
pany. Most  of  the  states  very  carefully  restrict  the 
investments  in  corporation  securities.  New  York 
prohibits  all  companies  doing  business  in  the  state 
from  investing  in  corporation  stocks.  Ohio  follows  the 
same  practice.  In  the  latter  state,  state  and  gov- 


RELATION  OF  THE   STATE  TO  INSURANCE    307 

eminent  bonds  cannot  be  purchased  when  their 
market  value  is  less  than  80  per  cent  of  their  par 
value. 

We  may  summarize  the  regulations  regarding  invest- 
ments as  follows  as :  (a)  The  tendency  to  prohibit  in- 
vestments in  real  estate  except  for  Home  Office  Build- 
ings is  marked,  but  more  liberality  is  found  in  regard  to 
loans  on  real  estate ;  (b)  more  liberal  provisions  regard- 
ing the  investment  in  public  securities  and  stricter  regu- 
lations of  the  investments  in  corporation  securities  is 
the  general  rule. 

Some  states  have  shown  a  decided  disposition  to 
require  a  large  amount  of  the  reserve  funds  on  policies 
to  be  invested  in  the  securities  of  the  state.  So  far  as 
the  legislation  had  for  its  purpose  the  protection  of  the 
funds  by  making  possible  a  better  knowledge  of  their 
actual  value,  there  was  some  justification  for  the  policy 
in  the  early  days,  when  correct  estimation  of  the  value 
of  securities  could  not  be  easily  made.  So  far  as  the 
legislation  has  for  its  purpose  the  keeping  of  money 
within  the  state,  it  was  more  than  questionable,  for  if 
the  securities  purchased  must  have  a  market  made  for 
them,  this  fact  was  at  least  presumptive  evidence  that 
these  securities  might  not  be  desirable  ones  for  an  insur- 
ance company. 

The  purpose  of  regulating  the  investments  of  insur- 
ance has  been  to  limit  the  investments  to  such  securities 
as  will  bear  the  inspection  of  the  public  and  guarantee 
the  security  of  the  funds.  There  are  many  who  think 
that  the  restrictions  are  too  severe  and  that  a  wide 
range  of  investments  should  be  permitted  under  the 


3o8  PRINCIPLES  OF  INSURANCE 

supervision  of  the  insurance  departments.  But  the 
element  of  risk  is  so  frequently  present  in  corporation 
securities  and  the  public  demand  is  so  insistent,  and 
rightly  so,  for  security  as  the  first  test  of  an  insurance 
investment,  that  notwithstanding  the  greater  return  to 
be  often  procured  from  corporation  securities,  there  is 
no  immediate  prospect  that  the  field  of  investments 
will  be  widely  extended. 

Certain  regulations  have  been  attempted  in  regard 
to  the  remuneration  of  officials  and  agents.  Some  states 
have  established  a  maximum  salary  to  be  paid  to  the 
president  and  maximum  commissions  to  agents,  and 
especially  the  amount  of  renewal  commissions  to  be 
paid,  that  is,  the  amount  paid  to  the  agent  on  premiums 
subsequent  to  the  first. 

Most  of  the  states  have  laws  prohibiting  rebating, 
that  is,  the  reduction  by  the  agent  to  the  purchaser  of 
the  first  premium ;  in  most  cases  the  penalties  imposed 
apply  only  to  the  agent  giving  the  rebate.  There  is  a 
tendency  in  some  quarters  to  punish  both  the  recipient 
and  giver  of  a  rebate.  No  company  or  its  employees 
is  permitted  in  most  states  to  issue  any  estimate  mis- 
representing the  terms  of  any  policy  issued  by  it  or 
the  benefits  or  advantages  promised. 

New  York  also  established  a  limitation  on  the  amount 
of  new  business  which  could  be  written  in  any  one 
year.  This  limit  is  decreasing  in  its  percentage  with 
the  increase  in  the  amount  of  business  on  the  books  of 
the  company.  The  New  York  law  also  limits  the  amount 
of  the  contingent  reserve  or  surplus  which  can  be  held 
by  a  company. 


RELATION   OF  THE  STATE  TO  INSURANCE    309 

Liquidation  of  Companies.  —  Some  states  have  en- 
acted laws  which  give  to  the  commissioner  of  insurance 
the  power  of  liquidating  companies  that  have  failed  or 
have  been  ordered  to  close  up  their  business,  or  when 
one  company's  business  is  being  absorbed  by  another. 
This  is  done  with  the  view  of  protecting  the  policy- 
holders  for  reasons  that  are  obvious  at  such  times  when 
there  is  a  temptation  for  the  officials  of  the  company  to 
benefit  at  the  expense  of  policyholders. 

In  other  states,  laws  have  been  passed  which  give  the 
Commissioner  the  sole  power  of  licensing  agents  and 
revoking  licenses  granted.  This  is  done  for  the  pur- 
pose of  securing  a  high  type  of  agent.  This  power 
becomes  especially  important  when  an  agent  is  guilty 
of  rebating. 

The  Commissioner  in  many  states  is  given  certain 
powers  over  unauthorized  business  and  surplus  insur- 
ance. In  the  first  case  he  prevents  and  prosecutes 
companies  from  writing  business  in  the  state  without  a 
license,  or  prosecutes  those  seeking  to  secure  insurance 
on  their  property  from  such  "  outside  companies." 
In  the  second  case  he  grants  the  privilege  to  agents  or 
brokers  or  property  holders  to  secure  insurance  from 
companies  not  regularly  admitted  in  case  they  cannot 
secure  sufficient  insurance  from  "  admitted  companies." 

Taxation  of  Insurance.  —  The  subject  of  taxation  is 
one  to  which  the  companies  have  most  consistently  and 
continuously  objected.  These  objections  are  based 
upon  two  grounds :  First,  it  is  argued  that  insurance 
is  not  a  proper  source  of  revenue  for  the  state,  and  sec- 
ond, that  there  is  no  uniformity  in  the  tax  in  the  differ- 


3io  PRINCIPLES  OF  INSURANCE 

ent  states.  It  is  argued  that  insurance  is  not  produc- 
tive; that  it  does  not  lead  directly  to  the  creation  of 
wealth,  but  on  the  contrary  aids  greatly  in  the  more 
equal  distribution  of  wealth ;  that  it  is  a  fund  set  aside 
from  income  to  care  for  those  dependent  upon  the 
producer  and  thus  relieves  the  state  from  supporting 
some,  who  otherwise  would  either  become  subject  to 
their  charity  or  would,  through  lack  of  adequate  prepa- 
ration, be  inefficient  producers  and  citizens;  that  the 
insurance  policy  is  not  a  form  of  income-bearing  prop- 
erty ;  that  the  premiums  are  a  form  of  self-imposed  tax. 

It  is  urged  that  the  policyholder  must  in  the  end  bear 
the  tax  in  the  form  of  a  higher  premium,  and  thus  the 
tax  acts  to  discourage  insurance  by  increasing  its  cost; 
that  whatever  of  funds  are  collected  from  policyholders 
are  so  invested  that  they  either  bear  a  tax  by  their 
investment  in  real  estate  loans  or  aid  the  treasury  of  the 
state  if  they  are  invested  in  state  or  local  government 
securities.  At  the  farthest  those  who  object  to  taxa- 
tion of  insurance  receipts  would  permit  only  such  a  tax 
as  would  support  the  insurance  department  of  the 
state,  that  is,  an  inspection  tax  or  fee.  The  taxes  are 
usually  levied  on  the  gross  premium  receipts  derived 
from  the  policyholders  in  the  state,  but  in  addition 
there  is  found  sometimes  a  state  license  tax,  a  charge 
for  filing  the  annual  statement,  agent  licenses,  and  city 
and  county  fees. 

The  home  companies  are  frequently  exempted  from 
paying  some  of  these  taxes  or  are  taxed  at  a  lower  rate 
than  foreign  companies.  This  practice  does  not  often 
accomplish  the  purpose  intended,  that  is,  it  does  not 


RELATION  OF  THE  STATE  TO  INSURANCE    311 

give  preference  to  home  companies,  because  most  of 
the  states  have  a  retaliatory  law  which  is  automatic  in 
its  operation.  That  is,  X  state  tends  to  tax  the  insur- 
ance companies  of  Y  state  at  the  highest  rate  levied 
by  Y  state  on  the  insurance  companies  of  X  state. 

The  state  tax  on  gross  premiums,  although  in  a  few 
cases  it  is  on  the  net  receipts,  varies  from  i  per  cent  to 
3  per  cent.  The  amount  collected  by  the  states  in  the 
form  of  licenses,  fees,  fines,  and  taxes  —  excluding  taxes 
on  real  estate  owned  —  from  ordinary  life  and  industrial 
companies  in  1914  was  about  thirteen  million  dollars. 
This  was  about  2  per  cent  of  the  total  premium  receipts 
of  these  companies  during  that  year.  It  has  been  urged 
that  the  tax  should  be  added  to  the  premiums  charged 
in  each  state  and  therefore  assessed  upon  those  policy- 
holders  whose  state  exacts  the  tax.  Whatever  theo- 
retical justification  this  plan  has  as  a  matter  of  equity, 
it  is  practically  impossible,  since  among  other  diffi- 
culties it  would  involve  different  rate  books,  policies, 
and  reports  for  the  different  states,  and  add  enormously 
to  the  bookkeeping  work  of  the  company  and  doubtless 
would  be  a  violation  of  the  antidiscrimination  statutes 
of  some  states. 

The  reasons  for  the  existence  of  the  tax  are  not  diffi- 
cult to  understand.  The  legislator  in  a  democracy  is 
constantly  seeking  revenue  from  sources  from  which 
objections  will  not  be  made.  The  large  accumulations 
of  funds  by  the  insurance  companies  can  be  used  with- 
out great  popular  objection.  Notwithstanding  that 
these  funds  are  chiefly  liabilities  for  obligations  already 
incurred,  they  afford  a  ready  source  of  revenue.  The 


3i2  PRINCIPLES  OF  INSURANCE 

real  owners  of  these  funds  —  the  policyholders  —  do 
not  even  perceive  the  burdens,  since  they  are  very 
numerous  and  the  amount  borne  by  each  is  very  small. 
The  availability  of  the  funds  for  taxation  and  the  ab- 
sence of  any  great  popular  objection  to  the  tax  would 
therefore  seem  to  be  the  chief  reason  for  the  tax.  It  is 
easy  to  get  and  therefore  is  taken  without  much  con- 
sideration of  the  equity  of  the  taking. 

Reasons  Assigned  for  Taxing  Insurance.  —  There 
are,  however,  those  who  argue  that  theoretical  as  well 
as  practical  grounds  justify  a  tax  on  Insurance,  espe- 
cially in  all  those  cases  where  the  insurance  organization 
is  in  the  form  of  a  stock  corporation.  Capital  has  been 
invested  in  these  stocks  by  the  owners  with  the  expecta- 
tion of  deriving  a  dividend  in  the  same  manner  that 
capital  is  invested  in  other  shares  of  stock.  The  results 
actually  secured  both  in  the  case  of  life  and  fire  stock 
insurance  companies  have  generally  justified  the  expec- 
tation. It  is  true  that  many  stock  insurance  companies 
have  failed,  just  as  many  mutual  companies  have  failed. 
But  there  are  many  examples  of  success. 

The  reply  that  even  in  this  case  there  is  double  taxa- 
tion is  not  sufficient,  for  as  every  elementary  student  of 
taxation  knows  there  are  many  cases  of  double  taxation 
justifiable  both  in  theory  and  practice.  Insurance 
taxation  may  be  a  tax  on  thrift  and  saving,  but  so  is  all 
taxation.  The  distinction  should  be  made  first  between 
that  saving  or  thrift  which  is  incurred  for  productive 
purposes  and  for  the  benefit  of  the  individual  saving  and 
that  incurred  for  the  benefit  of  those  other  than  the 
person  saving.  In  the  second  place  a  distinction  should 


RELATION   OF  THE  STATE  TO  INSURANCE    313 

be  made  between  the  number  and  character  of  those 
who  benefit  from  the  saving.  If  those  of  the  insured 
group,  that  is,  the  policyholders,  alone  benefit  from  the 
saving  of  the  individual  members  —  the  insured  —  and 
not  second  parties,  such  as  the  stockholders  in  a  com- 
pany, there  would  seem  to  be  strong  theoretical  grounds 
to  exempt  these  savings  from  any  tax.  The  policy- 
holders  in  a  mutual  company  have  banded  themselves 
together  to  protect  each  other  or  their  dependents 
against  any  existing  risks.  No  one  of  the  members 
expects  to  derive  any  special  profit  from  the  organiza- 
tion, and  its  benefits  are  open  to  any  one  who  chooses 
to  avail  himself  of  it.  If  such  organizations  could  be 
exempt  from  taxation  as  a  distinct  source  of  revenue 
for  the  state,  these  benefits  would  be  granted  its  mem- 
bers at  a  lower  cost.  The  state  would  be  deprived  of  an 
easy  source  of  revenue,  but  the  ends  of  justice  should 
always  be  of  more  importance  to  the  state  in  its  activ- 
ities than  matters  of  expediency. 

So  long  as  the  stock  company  is  a  form  of  the  insur- 
ance organization,  it  will  be  difficult  to  convince  the 
legislator  that  insurance  should  be  exempt  from  taxa- 
tion. The  tax  is  undoubtedly  shifted  to  the  policy- 
holder  in  the  form  of  a  higher  cost  for  his  insurance. 

The  Annual  Report.  —  The  character  of  the  annual 
report  to  a  state  may  be  indicated  from  the  following 
items  reported  to  the  New  York  Department  by  a  repre- 
sentative life  insurance  company. 

i.  Income  and  Disbursements;  Assets  and  Liabil- 
ities in  the  form  of  a  balance  sheet  beginning  with 
the  ledger  assets  of  the  previous  year,  and  ending  with 


3i4  PRINCIPLES  OF  INSURANCE 

the  gross  assets  as  admitted  by  the  Insurance  Depart- 
ment. 

2.  An  Exhibition  of  Policies,  showing  the  number  and 
amounts  in  force  at  the  beginning  and  end  of  the  year 
and  the  changes  during  the  year.    This  is  made  for  the 
State  of  New  York  on  the  basis  of  paid-for  business 
only ;     for    other    states  —  as    their    laws     require  — 
either  on  a  paid-for  basis  or  an  issued  basis. 

3.  Business  in  the  State  of  New  York  in  brief  —  the 
copies  going  to  other  states  containing  an   exhibit  of 
the  business  in  those  states. 

4.  Gain  and  Loss  Exhibit,  showing  actual  expenses, 
interest  and  mortality  in  connection  with  legal  allow- 
ances and  office  assumptions  respectively;    the  profits 
from  lapses  and  surrenders,  gain  and  loss  on  invest- 
ments, etc. 

5.  Premium  Note  account. 

6.  Schedule  of  cash  and  deposits  of  the  Home  Office 
with  banks  and  trust  companies  in  the  United  States 
and  Canada ;  and  cash  with  foreign  banks,  governments, 
and  Branch  Offices. 

7.  Special  and   General  Deposit  Schedules,  showing 
in  detail  the  securities  deposited  with  the  authorities 
of  different  states  and  countries  in  pursuance  of  legal 
requirements. 

8.  Real   Estate   Schedule,    showing   each   parcel   of 
property ..  owned  by  the  company,  with  particulars  of 
cost,   income,   taxes,   and  improvements;    also  details 
of  all  purchases  and  sales  made  during  the  year. 

9.  Mortgage    Schedule,    with    description,    location, 
etc.,  of  each  piece  of  property  mortgaged  to  the  com- 


RELATION  OF  THE   STATE  TO  INSURANCE    315 

pany ;  also  an  account  of  mortgage  loans  made,  in- 
creased, reduced,  discharged,  or  disposed  of  during  the 
year;  also  showing  the  amount  loaned  in  each  state 
and  foreign  country. 

10.  Collateral  Loan  Exhibit,  with  similar  information. 

11.  Bond    Schedule,    showing   in    detail    the   bonds 
owned,  with  book,  par,  and  market  values ;  date  of  pur- 
chase and  from  whom  acquired,  interest  received,  etc. ; 
also  separate  schedules  of  all  bonds  acquired  or  dis- 
posed of  during  the  year,  with  the  profit  or  loss  on  each 
lot  sold. 

12.  Schedule  of  Bank  Balances,  showing  the  largest 
balance  carried  in  each  bank  and  trust  company  in 
each  month  of  the  year. 

13.  Schedule  of  Contested  Policies,  showing  name  and 
residence  of  insured,  amount  of  Policy,  reason  for  con- 
testing;   also  all  settlements  of  contested  cases  made 
during  the  year. 

14.  Schedule  of  Salaries,  Compensation,  and  Emolu- 
ments of  all  persons  or  corporations,  to  whom  $5000  or 
over  was  paid  during  the  year. 

15.  Schedule   showing  all  salaries  paid  for  agency 
supervision. 

1 6.  Schedule  showing  all  commissions  paid  on  loans 
or  on  purchase  or  sale  of  property  during  the  year. 

17.  Schedule  of  Legal  Expenses,  showing  amounts, 
to  whom  paid,  and  for  what  service  rendered. 

1 8.  Schedule    of    Expenditures,    in    connection   with 
matters  before   legislative   bodies,   officers,   or   depart- 
ments of  government. 

19.  Dividend  Schedule,  showing  dividends  paid  under 


3i6  PRINCIPLES  OF  INSURANCE 

all  forms  of  policies  in  various  years  and  for  various 
ages;  including  explanations  of  the  methods  by  which 
dividends  were  calculated  on  all  classes  of  policies. 

20.  Schedule  showing  in  detail  all  money  expended  in 
connection  with  the  election  of  directors. 

21.  In  addition  to  this  printed  form  Policy  Valuation 
Schedules  are  furnished,  showing  in  groups,  by  kind  of 
Policy,  amount  of  insurance,  age  of  insured,  and  years 
in  force,  the  data  necessary  for  making  a  complete  val- 
uation of  its  Policy  liabilities. 

Some  specific  phases  of  the  regulation  of  fire  insur- 
ance need  to  be  emphasized.  Much  of  what  has  been 
previously  discussed  refers  both  to  life  and  fire  insur- 
ance. The  method  of  organizing  a  fire  insurance  com- 
pany, the  requirements  as  to  the  investment  of  their 
funds,  and  the  valuation  of  the  reserve  have  also  been 
described.  The  solvency  of  the  large  fire  insurance 
companies  is  no  longer  a  subject  of  particular  concern 
to  the  people.  Most  of  the  legislation  referring  to  this 
phase  of  the  business  has  long  been  on  the  statute  books, 
and  its  results  in  operation  have  been  on  the  whole 
satisfactory. 

Fire  Insurance  Rates  the  Chief  Subject  of  Regulation. 
-  The  one  problem  in  the  regulation  of  fire  insurance 
which  has  occasioned  most  interest  is  that  of  rates. 
It  is  but  one  aspect  of  the  widely  prevalent  disposition 
on  the  part  of  legislative  bodies  to  regulate  prices  in  the 
interest  of  consumers.  In  fire  insurance  the  rating 
problem  is  technical  and  therefore  difficult  of  under- 
standing for  the  legislator  and  the  public.  The  efforts 
to  regulate  such  rates  are/  recent  and  no  general  agree- 


RELATION  OF  THE   STATE  TO  INSURANCE    317 

ment  is  found  as  to  the  best  method  to  be  used.  The 
attempt  to  regulate  rates  arises  from  a  desire  both  to 
protect  the  public  from  a  supposed  monopoly  price  and 
to  secure  equitable  rates.  The  first  desire  has  expressed 
itself  in  the  numerous  anti-combination  laws,  which 
usually  have  attempted  to  prevent  the  fire  insurance 
companies  from  making  agreements  to  determine  rates, 
and  to  observe  them  in  practice  and  to  agree  upon  the 
commission  to  be  paid  agents ;  that  is,  there  has  been  a 
popular  belief  that  fire  insurance  companies  were  fre- 
quently guilty  of  monopolistic  action  with  its  attendant 
public  injury. 

Antitrust  Legislation  and  Insurance.  —  In  the  last 
quarter  of  a  century  there  has  been  manifested  a  great 
public  opposition  to  monopolies  and  suspicion  is  always 
alert  on  this  subject.  The  fire  insurance  companies 
were  observed  to  agree  in  their  rates  in  many  cases, 
but  on  risks,  apparently  the  same  to  the  superficial 
observer,  the  rates  would  be  different.  The  public, 
which  was  not  informed  as  to  all  the  elements  enter- 
ing into  a  rate,  very  naturally  concluded  that  the  charges 
were  both  monopolistic  and  discriminatory.  Associa- 
tions of  fire  underwriters  which  often  made  rates  were 
numerous.  At  first  such  monopolistic-appearing  or- 
ganizations of  the  fire  insurance  companies  were  at- 
tacked under  the  common  law.  The  courts  in  general 
refused  to  hold  such  associations  or  similar  ones  among 
the  companies  to  agree  upon,  fix,  and  maintain  rates  as 
illegal  in  themselves  to  the  extent  that  the  persons  were 
guilty  of  an  act  justifying  a  criminal  or  civil  action. 
At  most  these  agreements  to  fix,  regulate,  and  control 


3i8  PRINCIPLES  OF  INSURANCE 

the  business  of  fire  insurance  were  held  to  be  unenforce- 
able. If  the  restraint  of  trade  which  resulted  was 
unreasonable  in  its  effects  upon  the  public  interest, 
they  could  be  dissolved.  But  few  successful  actions 
at  law  against  such  combinations  under  the  common 
law  principle  of  monopolies  and  combinations  were  had. 
When  this  common  law  principle  had  become  expressed 
in  the  statutory  antitrust  laws  of  the  various  states, 
fire  insurance  organizations  were  attacked  in  the  courts 
under  these  statutory  laws.  But  when  these  laws  were 
enacted,  fire  insurance  organizations  were  not  usually 
in  the  mind  of  the  legislator  as  a  monopoly  to  be  thus 
regulated.  It  was  common  for  these  antitrust  laws  to 
refer  in  their  terms  to  "  merchandise  and  commodity  " 
or  similar  business  which  did  not  include  fire  insurance. 
The  courts  very  generally  refused  to  interpret  "  trade," 
"  merchandise,"  "  commodity,"  and  such  words  as 
including  fire  insurance.  Since  no  relief  adequate  to 
the  situation  in  the  opinion  of  the  public  was  to  be  had 
either  from  the  common  law  or  the  antitrust  laws,  many 
states  enacted  specific  anticompact  or  combination 
laws  which  applied  specifically  to  fire  insurance  com- 
panies, although  some  states  amended  their  antitrust 
laws  to  include  specifically  insurance  companies.  These 
laws  have  been  upheld  by  the  courts,  since  insurance  has 
been  held  not  only  to  be  a  public  business  but  also  not 
an  interstate  business  within  the  meaning  of  the  federal 
constitution. 

Some  of  these  laws  are  of  a  very  stringent  character, 
and  only  in  a  minority  of  the  states  is  there  a  legal  recog- 
nition of  the  fact  that  rates  in  fire  insurance  should  be 


RELATION  OF  THE   STATE  TO  INSURANCE    319 

cooperatively  made  instead  of  being  competitively  made. 
The  history  of  competitive  rate-making  in  fire  insur- 
ance is  so  full  of  examples  of  public  injury  that  there  is 
little  intelligent  opinion  on  the  subject  which  would 
argue  for  its  continuance.  The  chief  interest  of  the 
public  as  well  as  of  the  insurance  companies  is  in  the 
stability  and  solvency  of  insurance.  To  secure  these 
ends  and  at  the  same  time  receive  fair  rates  two  methods 
of  rate-making  are  open. 

How  Rates  May  Be  Made.  —  First,  the  state  may  fix 
and  approve  minimum  rates,  trusting  to  the  forces  of  com- 
petition among  the  companies  to  prevent  unduly  high 
rates.  The  greater  part  of  the  evils  connected  with 
fire  insurance  rates  have  not  resulted  from  high  or  maxi- 
mum rates  but  from  low  rates ;  that  is,  all  the  attendant 
evils  of  rate-cutting  and  discrimination.  Minimum 
rates,  therefore,  in  a  system  of  rate-fixing  by  the  state 
are  more  important  than  attempting  to  establish  spe- 
cific rates  for  each  risk  and  class  of  property. 

Second,  the  state  may  allow  the  companies  to  combine 
for  the  purpose  of  making  and  maintaining  rates,  and  su- 
pervise carefully  these  acts  of  the  companies.  Both  of 
these  methods  are  in  practice  in  the  United  States,  al- 
though but  a  few  states  have  attempted  to  fix  rates. 
This  second  method  often  takes  the  form  of  legalizing  rat- 
ing bureaus,  since  these  are  the  most  economic  agency  for 
rate-making.  These  bureaus  may  be  independent  organ- 
izations or  they  may  be  composed  of  the  representatives  of 
the  companies.  The  state  through  its  department  deals 
with  the  companies  on  the  subject  of  rates  through  the 
bureau,  and  in  some  states  these  bureaus  are  becoming 


320  PRINCIPLES  OF  INSURANCE 

quite  as  much  an  agency  to  represent  the  interests  of 
the  public  as  the  companies;  that  is,  they  act  contin- 
uously as  a  force  to  compel  individual  companies  to 
observe  rates  and  are  more  closely  related  to  the  work  of 
the  insurance  department  of  the  state  than  to  the  offices 
of  the  companies. 

In  some  states  neither  of  the  above  methods  are  used ; 
that  is,  the  state  simply  requires  the  company  to  file 
rates  with  a  state  official;  or  the  state  official  may  be 
given  power  to  supervise  rates  only  in  certain  particu- 
lars, such  as  seeing  that  rates  are  not  discriminatory. 
At  the  present  writing  there  is  no  uniformity  in  the 
regulation  of  fire  insurance  rates  in  the  different  states, 
although  the  tendency  seems  to  be  toward  state  super- 
vision of  rates  rather  than  state  rate-making.  Prob- 
ably no  other  one  thing  would  so  much  improve  the 
fire  insurance  business  as  the  adoption  by  all  states  of 
a  state  system  of  supervising  rates  which  would  compel 
all  companies  to  cooperate  in  making  and  maintaining 
rates. 

Discrimination  and  State  Regulation.  —  Discrimina- 
tion, which  has  too  often  been  prevalent,  would  be  largely 
removed,  at  least  in  the  particular  state,  by  such  a  sys- 
tem. It  will  require,  however,  a  farsighted  and  broad 
viewpoint  on  the  part  of  the  regulating  official  if  dis- 
crimination is  to  be  avoided  as  between  states.  Due 
allowance  should  be  made  in  the  rates  of  each  state  for 
the  conflagration  hazard.  Again,  the  mere  fact  that  ' 
property  of  a  similar  character  in  one  state  enjoys  a 
particular  rate  does  not  prove  that  the  same  rate  is  a 
fair  one  in  another  state  because,  as  has  been  shown,  there 


RELATION  OF  THE  STATE  TO  INSURANCE    321 

is  a  very  wide  difference  in  the  burning  rate  in  differ- 
ent states.  This  discrimination  as  regards  states  will 
probably  be  the  most  difficult  problem  in  a  system  of 
state-supervised  rates,  since  each  state  will  think  it  is 
entitled  to  as  low  rates  as  any  other  state,  just  as  the 
individual  property  owner  or  a  village  is  disposed  to 
think  his  or  its  rates  should  be  as  low  as  that  of  the  neigh- 
boring property  or  village.  Yet  if  the  system  of  sched- 
ule rating  is  developed  and  the  classified  experience  of 
companies  is  better  collected  and  made  public,  there  is 
hope  of  convincing  both  insured  property  owners  and 
communities  that  the  rates  are  fair.  It  has  been  too 
often  the  case  in  the  past  that  neither  the  agent  nor  the 
company  could  give  any  satisfactory  explanation  to  the 
property  owner  or  the  community  for  the  difference  in 
rates  as  compared  with  other  property  and  communities. 

Discrimination  as  to  persons,  as  to  property  of  the 
same  kind,  and  as  to  communities  and  states  has  existed 
as  an  evil  in  fire  insurance.  The  promise  of  its  disap- 
pearance is  in  a  system  of  combined  experience,  proper 
rating,  enforced  cooperation,  and  careful  supervision 
by  state  officials. 

No  system  of  supervision  will  solve  the  problem  of 
fire  insurance  rating  in  the  sense  that  it  is  possible  to 
determine  what  specific  rates  should  be.  Rates  will 
continue  to  change  with  the  varying  conditions  of  build- 
ing material,  the  construction  and  use  of  buildings,  and 
the  other  fluctuating  factors  affecting  the  rates.  But 
discrimination  can  be  removed  and  equity  as  to  classes 
of  property  secured.  Finally,  regulation  of  rates  can 
do  much  to  reduce  the  unnecessary  fire  loss  by  making 


322  PRINCIPLES  OF  INSURANCE 

those  responsible  for  it  bear  the  large  cost,  which  results 
from  their  carelessness.  , 

It  is  doubtless  true  that  much  of  the  legislation  en- 
acted to  govern  the  business  of  fire  insurance  has  been 
unwise,  but  the  explanation  of  its  origin  and  character 
is  not  difficult,  nor  are  the  insurance  companies  to  be 
held  blameless  as  a  cause  of  it.  There  are  many  points 
of  similarity  between  the  railway  legislation  and  the 
fire  insurance  legislation.  The  high-handed  methods 
of  some  of  the  earlier  railway  administrators,  the  evils  of 
the  rate  wars,  the  discriminations,  and  a  multitude  of 
lesser  evils  produced  in  the  public  mind  an  attitude 
of  hostility  to  all  railways  which  only  in  recent  times 
has  shown  any  indication  of  abatement.  There  was  a 
tendency,  as  is  common  in  social  action,  to  go  to  extremes, 
and  along  with  the  constructive  legislation,  laws  were 
enacted  detrimental  both  to  the  public  and  the  railways. 
Many  of  the  reforms  forced  upon  the  railways  are  of 
permanent  value,  as,  for  example,  the  uniform  system 
of  reporting  expense,  and  as  in  many  other  instances, 
such  uniformity  would  hardly  have  been  adopted  volun- 
tarily by  the  different  companies. 

In  a  like  manner  the  public  bill  of  indictment  against 
the  fire  insurance  companies  is  not  without  foundation. 
In  fact  many  of  the  counts  in  this  bill  of  indictment  "will 
stand  the  test  of  a  careful  investigation.  The  forms 
and  results  which  the  competition  among  fire  insurance 
companies  has  assumed  often  have  been  beyond  the 
comprehension  of  the  public  mind.  The  public  has  not 
only  witnessed  the  violent  cutting  of  rates  at  the  time 
of  rate  wars,  but  it  has  also  experienced  a  considerable 


RELATION  OF  THE   STATE  TO  INSURANCE    323 

variation  of  rates  among  the  companies  on  the  same 
risk  in  times  of  peace.  It  has  observed  that  rates  on 
apparently  identical  risks  in  the  same  locality,  or  in 
similar  localities,  have  varied  widely.  This  fluctuation 
in  rates,  now  high,  now  low,  now  stable  in  the  face  of 
evident  improved  conditions,  and  unstable  in  the  face 
of  no  changes,  has  caused  the  public  to  wonder  if  the 
fire  insurance  companies,  collectively  or  individually, 
have  any  really  scientific  method  of  determining  rates; 
whether,  after  all,  rates  are  not  a  matter  either  of  guess- 
work, or  of  charging  what  the  traffic  will  bear ;  that  is, 
the  fire  insurance  companies  were  getting  as  much  as 
they  could,  wherever  they  could. 

Then,  too,  the  apparently  large  expense  of  fire  insur- 
ance companies  has  been  a  source  of  wonder  to  the  public. 
Nor  have  the  cases  of  over-insurance,  careless  inspec- 
tion, and  other  attendant  evils  of  excessive  competition 
escaped  public  attention.  When  the  companies  have 
been  called  upon  to  explain  and  justify  their  acts,  they 
have  sometimes  not  been  able  to  make  an  explanation 
satisfactory  to  the  public,  due  partly  to  the  fact  that 
much  of  the  explanation  was  technical,  and  partly  to 
the  fact  that  there  was  no  satisfactory  explanation 
to  be  made.  The  public  itself  is  responsible  for  much 
of  the  difficulty.  It  has  insisted  upon  competition  in  all 
respects  and  has  paid  the  price  for  it.  But  when  all 
allowance  for  the  public's  share  in  the  situation  is  made, 
there  remains  a  residuum  of  blame  which  must  be  borne 
by  the  companies.  The  chief  source  of  this  weakness 
is  in  the  absence  of  standards  in  the  fire  insurance 
business.  With  the  exception  of  a  standard  policy  — 


324  PRINCIPLES  OF  INSURANCE 

and  it  has  many  modifications  —  the  fire  insurance 
business  has  fewer  standards  than  any  business  in  the 
world.  There  is  no  standard  for  measuring  hazards, 
no  standard  classifications,  no  standards  of  expense, 
no  standards  of  accounting,  and  in  fact  no  standards 
for  doing  a  business,  which,  on  account  of  its  great 
complexity,  is  greatly  in  need  of  measuring  units.  The 
individual  companies  have  been  loath  to  join  in  cooper- 
ative movements  to  work  out  such  standards,  not  pri- 
marily as  they  often  assert  because  of  fear  of  the  law, 
but  rather  because  the  whole  history  of  the  business  in 
the  United  States  has  placed  a  discount  on  such  co- 
operation. It  is  very  doubtful  if  this  full  cooperation, 
which  alone  will  make  possible  a  standardization  of  the 
business,  will  ever  result  except  from  public  compulsion. 
The  splendid  work  of  the  National  Board  of  Fire  Under- 
writers made  an  excellent  beginning  when  it  aided  in 
the  devising  of  a  Standard  Policy,  and  even  greater 
results  are  now  promised  through  the  work  of  its  Actu- 
arial Bureau. 

The  only  prospect  that  the  marked  tendency  to  enact 
more  restrictive  fire  insurance  laws  will  be  checked 
is  for  the  companies  to  work  out  in  cooperation  stand- 
ards for  the  business.  They  must  be  able  to  explain 
more  satisfactorily  to  the  public  how  they  make  their 
rates,  how  they  spend  their  receipts,  how  they  classify 
the  risks,  what  their  losses  are  on  classes  of  property 
and  in  different  political  divisions.  The  business  of 
fire  insurance  is  a  public  one,  and  its  relations  to  public 
welfare  are  so  vital,  and  to  other  businesses  so  important, 
that  in  time  the  public  will  insist  that  it  be  conducted 


RELATION  OF  THE^STATE  TO  INSURANCE    325 

not  only  in  the  most  careful  and  businesslike  manner, 
but  also  that  the  methods  be  continuously  open  for 
public  inspection  and  understanding.  The  courts  have 
many  times  upheld  the  power  of  extreme  control  over 
the  business  of  fire  insurance,  and  public,  or  state,  fire 
insurance  promises  no  benefits  which  cannot  better  be 
secured  by  public  control  of  the  business  under  private 
ownership.  Whatever  reforms  are  needed  can  be  best 
accomplished  by  the  fire  insurance  companies  them- 
selves. 

A  greater  degree  of  cooperation  with  the  ends  in  view 
of  restricting  undesirable  competition  and  of  devising 
standards  for  the  business  is  the  great  need  of  the  fire 
insurance  business. 

REFERENCES 

Insurance  and  the  State.    W.  F.  Gephart. 
The  Business  of  Insurance,  Vol.  Ill,  Chaps.  67,  69,  72. 
Yale  Readings  in  Insurance,  Chaps.  23,  24. 
The  Insurance  Year  Book  1915.     Life,  Casualty  and  Miscella- 
neous, pp.  1-86. 


SELECTED  BIBLIOGRAPHY  ON  FIRE  INSURANCE 

Business  of  Insurance,  the  three  volumes.    Howard  P.  Dunham, 

Editor. 

Brinkerhoff,  J.  J.    How  to  Examine  a  Fire  Insurance  Company. 
Crosby,  E.  N.,  and  Fiske,  Henry  A.    Handbook  of  Fire  Protec- 
tion. 

Dana,  Gorham.    Automatic  Sprinkler  Protection. 
Dean,  A.  F.    Fire  Rating  as  a  Science. 

Rationale  of  Fire  Rates. 

Fire  Insurance  Classification  (Pamphlet). 

Fire  Hazard,  Is  it  Measurable  ?  (Pamphlet.) 
Factory  Mutual  Insurance.    Arkwright  Mutual  Fire  Insurance 

Company. 

Griswold,  J.    The  Fire  Underwriters  Textbook. 
Hall,  Thrasher.    Handbook  of  Fire  Insurance  Adjustments. 
Hess,  H.  M.    An  Analysis  of  the  Dean  System  of  Fire  Insurance 

Rating. 

Huebner,  Solomon.    Property  Insurance. 
Jack,  A.  Finland.     Fire  Insurance  and  the  Municipalities. 
Lectures  on  Fire  Insurance.    The  Insurance  Library  Association 

of  Boston. 

Massachusetts  Insurance  Reports. 
Moore,  Francis  C.    Fire  Insurance  and  How  to  Build. 

Construction  Material. 
New  York  Insurance  Reports. 

National  Board  of  Fire  Underwriters,  Annual  Proceedings. 
National  Fire  Protection  Association,  Annual  Proceedings. 
Publications  of  Insurance  Society  of  New  York. 
Publications  of  Insurance  Society  of  Boston. 
Richards,  George.    A  Treatise  on  the  Law  of  Insurance. 
Richards,  E.  G.    The  Experience  Grading  and  Rating  Schedule. 

327 


328  PRINCIPLES  OF  INSURANCE 

Transactions  of  Insurance  and  Actuarial  Society  of  Glasgow. 
Von  Schwartz.    Fire  and  Explosion  Risks. 
Walford,  Cornelius  B.    The  Insurance  Cyclopedia,  5  volumes. 
Year  Book,  The  Insurance.    Fire  and  Marine,  Vols.  1-43. 
Young,  T.  E.    Insurance  Office  Organizations,  Management,  and 
Accounts. 


INDEX 


Agencies 

educational,  262 

private,  reducing  fire  loss,  263 

public,  reducing  fire  loss,  270 
Agency  system,  multiple,  73 
Agent  (see  also  agents) 

relation  of,  to  company  and  policy 
holder,  65 

work  of,  71 
Agents 

organization  of,  67 

power  of  early,  64 

special,  66 
Annual  report,  313 

Antitrust  legislation  and  insurance,  317 
Appraiser,  173 
Arson,  256 

Assets,  table  of,  227,  239 
Associations,  classification  of,  69 

B 

Board  of  directors,  48 

Broker,  75 

Bubble  period  of  fire  insurance,  n 

Buildings,  height  of,  271 


Chart  of  loss  ration,  88 
Charter,  78 
Classification 

and  rates,  105 

on  basis  of  industry,  106 

on  basis  of  political  divisions,  109 

value  of,  and  limits,  no 
Comity,    state,    in    regulation    insur- 
ance, 304 
Commissions 

are  they  too  large,  80 

contingent,  81 


Companies  (see  also  company) 

character  of  early,  in  U.  S.,  15 

early  English,  10 

early   foreign   and   domestic,   stock 
and  mutual,  18 

examination  of,  302 

failure  of,  240 

insurance,  and  fire  losses,  39 

risk  in,  29 
Company 

function  of,  28 

organization  of,  46 
Competition 

and  fire  cost,  42 

evil  effects  of  excessive,  292 
Contract 

basis  of  settlement  in,  168 

cancellation  of,  159 

clauses  limiting  liability  in,  183 

co-insurance  clause  in,  192 
effect  of,  199 
justification  of,  202 

conditions  subsequent  to  settlement 
in,  169 

contribution   and    mortgage    clause 
in,  206 

is  it  one  of  indemnity,  178 

mortgage  clause  in,  206 
effects  of,  208 

nature  of,  139 

personal,  140 

settlement  clauses  in,  167 

three-fourth  loss  clause  in,  186 

three-fourth  value  clause  in,  184 

valued-policy  clause  in,  186 


D 


Departments,  fire  and  water  works,  273 
Development  of  insurance,  conditions 
preventing  early,  i 


329 


330 


INDEX 


Directors,  board  of,  48 
Disbursements,  table  of,  227 
Discrimination  in  rating,  i2g,  131 
Dividend 

and  profits,  235 

distributions,  306 
Dividends,  242 

table  of,  243 

E 

Educational  agencies,  262 
Expense 

classification  of,  229 

element,  228 

how  to  reduce,  231 

tax  element  in,  232 
Exposure,  04 


Failure  of  companies,  240 
Fallacies  regarding  insurance,  279 
Field  force,  64 
Fire 

departments  and  water  works,  273 

marshals,  272 

prevention  and  protection,  259 
Fireproof  buildings,  261 
Fires 

causes  of,  258 

table  of,  260 

H 

Hazard 

conflagration,  95 

defined,  84 

in  life  and  fire  insurance,  84 

legal  aspects  of,  98 

moral,  97 

time  element  in,  87 
Hazards 

classification  of,  85 

occupancy,  92 

physical,  89 
Height  of  building,  90 


Indemnification,  155 
Indemnity,  178 
Inspection,  effects  of,  264 


Insurance  (see  also  insurance,  fire) 

advantages  of  federal  regulation  of, 
296 

and  distribution,  36 

aspect  of  the  guilds,  4 

conditions  preventing  early  develop- 
ment of,  i 

development  of,  23 

efforts  to  secure  federal  regulation  of, 
295 

is  it  competitive  business,  290 

is  it  monopoly,  40 

is  it  public  or  private  business,  288 

marine,  importance  of,  16 

mutual,  versus  stock,  8 

precursors  of  modern,  3 

public,  versus  private,  8 

reasons  for  taxing,  312 

regulation  of,  29 
early,  297 

risk  in,  31 

social  basis  of,  i 

Supreme  Court  decisions  in,  294 

taxation  of,  309 
Insurance,  fire 

and  credit,  35 

and  production,  34 

bubble  period  of,  1 1 

defined,  27 

early  proposals  in  England,  5 

general  statistics  of,  26 

how  conducted,  45 

mutual,  versus  stock,  8 

New  York,  18 

public,  versus  private,  8 

risk  in,  31 
Interest,  insurable,  204 

mortgage  and,  204 
Inter-insurance  organizations,  58 
Investments 

regulation  of,  226,  306 

state  regulation  of,  225 


Liquidation  of  companies,  309 

Lloyds,  56 

Loss  (see  also  loss,  fire,  and  losses) 
disagreements  as  to,  170 
methods  of  determining,  172 


INDEX 


331 


Loss,  fire,  37,  245 

agencies  reducing 
private,  263 
public,  270 

causes  of,  250 

construction  and,  251 

direct,  154 

factora  reducing,  261 

legal  liability  and,  254 

regulation  and,  255 

significance  of,  245 
Losses 

fire  and  insurance  companies,  39 

table  of,  88,  194,  196,  247,  249,  250, 
252,  2S3 

M 

Map,  fire  and  standard  policy,  22 
Marshals,  fire,  272 
Monopoly,  is  insurance  a,  40 
Mutual  (see  also  mutuals) 

organizations,  49 

plan  compared  with  stock,  53 
Mutuals 

advantage  of,  52 

factory,  51 

local,  49 

O 

Organization  (see  also  organizations) 

divisions  of,  62 

home  office,  63 

internal,  of  stock  company,  61 
Organizations 

inter-insurance,  58 

in  U.  S.  and  England,  13 

mutual,  49 
Overinsurance,  256 


Policies 

early  (see  also  policy),  141 

standard,  importance  of,  143 
Policy 

blanket,  161 

conditions  voiding,  156 

denned,  139 

explanation  of,  153 


Policy  —  Continued 

floating,  162 

leasehold,  164 

open,  161 

personal  and  time  element  of,  153 

profit,  164 

regulation  as  to  kinds  of,  305 

rent,  163 

sprinkler  leakage,  165 

standard,  144,  153 

use  and  occupancy,  162 
Premium,  210 

as  tax,  212 

character  of,  337 

determination  of,  217 

table  of,  214,  218,  220 

unearned,  215 
Profit 

discussion  of,  237 

dividend  and,  235 

rules  for  determining,  236 

source  of,  235 

underwriting  and  gross,  236 
Property 

location  and  character  of,  155 

removal  of,  159 

vacancy  of,  158 
Protection,  93 


Rate  (see  also  rates  and  rating) 

denned,  102 

disagreement,  as  source  of,  103 

fire  and  life  compared,  197 

fire  insurance  compared  with  tax,  192 

theoretical  bases  of,  104 
Rates 

chief  subject  of  regulation,  316 

classification,  105 

control  of,  by  a  state,  134 

determination  of ,  competition  in,  125 

discrimination  in  fire  insurance,  129, 

high,  expense  as  cause  of,  133 
making  of,  124,  319 
table  of,  112,  196,  214 
uniformity  in,  128 
Rating 
analytical  system  of,  117,  119 


332 


INDEX 


Rating  —  Continued 

early  system  of,  114 

experience,  120 

L.  and  L.,  1 23 

public  and  private,  126 

schedule  of,  115 

universal  mercantile,  115,  119 
Reinsurance  reserve,  217 
Report,  annual,  313 
Reserves 

disadvantages    of,     to    new    com- 
panies, 222 

significance  of,  221 
Riders,  160 
Risk 

element  of  interest  in,  30 

in  life  and  fire  insurance,  31 

in  stock  and  mutual  companies,  29 

nature  of,  30 

steps  in  writing,  77 
Roof,  91 


Schedule  rating 

analytical,  117,  119 

experience,  120 

L.  and  L.,  123 

universal  mercantile,  115,  119 
Social  basis  of  insurance,  i 
Solvency,  standards  of,  304 
Sprinklers,  automatic,  265 

efficiency  of,  268 

wet,  dry  and  open,  267 
State  comity  in  regulation  insurance, 

304 
State  regulation 

of  insurance 
and  discrimination,  320 


State  regulation  —  Continued 
bases  of,  277,  297 

of  investments,  225 
Statistics  of  general  fire,  26 
Stock  company,  internal  organization 

of,  61 
Stock  plan 

advantages  of,  54 

compared  with  mutual,  53 
Subrogation,  174 

assigning  right  of,  176 
Supreme  Court  decisions  on  insurance, 

294 
Surplus,  224 

lines,  158 

necessity  for,  61 


Table  of 

assets,  227,  239 

disbursements,  228 

dividends,  243 

fires,  260 

losses,  88,  194,  196,  247,  249,  250, 
252,  253 

premium,  214,  218,  220 

rates,  112,  196,  214 

ratios,  231 

Taxation  of  insurance,  309 
Tax  element  in  expense,  232 


U 


Underwriters,  national  board  of  fire,  ai 


Valued-policy  laws,  187 
assigned  basis  for,  190 


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